The Behavior of Others as a Reference Point

We study a model in which consumers are reference-dependent, modeled using prospect-theory, and their reference point is the average behavior of the society in that period. We show that in any of the equilibria of the economy after a finite number of periods the wealth distribution will become, and remain, either of perfect equality, or admit a ‘missing class’ (a particular form of polarization). We then study growth rates and show that, if we look at the equilibria with the highest growth, then the society with the highest growth rate is the one that starts with perfect equality. If we look at the equilibria with the lowest growth, however, then the society with a small amount of initial inequality is the one that attains the highest growth rate, while a society with perfect equality is the one with the lowest performance. All of these growth rates are weakly higher than the growth rate of a corresponding economy without reference-dependence.