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Choosing the Joneses On the Endogeneity of Reference Groups

  • Armin Falk
  • Markus Knell

A growing economic literature recognizes and deals with the fact that economic agents' utility and well-being is not solely determined by absolute achievements, but also by achievements relative to a reference standard or reference group. In this literature it is assumed that the reference standard is completely exogenous. Social psychologists have questioned the exogenous nature of the comparison process ("forced comparison conception") and have emphasized that people play a more active role in the determination of their reference standards ("coping approach"). The present paper takes up this idea. In our model the reference standard is determined endogenously. Following the social comparison literature we assume that in choosing the optimal reference standard people pursue goals of self-improvement and self-enhancement. Our model predicts that the optimally chosen reference standard (or group) increases in people's abilities. We present new questionnaire data together with a review of various important findings from social perception studies (minimum income, happiness, subjective social class). It turns out that the empirical regularities conform well to the predictions of our model, but are difficult (if not impossible) to explain by both the standard economic approach (with its neglect of social comparison) and the forced comparison approach.

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Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 053.

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