Relative Income Hypothesis

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Relative Income Hypothesis

James Duesenberry, who put forward and relative income hypothesis suggests that the most basic consumption relationship is proportional in the long-run.

The relative income hypothesis put forward by Duesenberry maintains that the fractions of a family's income devoted to consumption depend upon the level of its income relative to the income of the neighboring families or other person with whom they come into frequent contact, and not on the absolute level of income of that family alone This is so because peoples’ tastes, preference, etc., are essentially interdependent and therefore an individual's consumption pattern may be more influenced by the consumption pattern of this neighbors or friends than by his own income. An individual earning say $10,000 per month will be spending more consumption if he lives in a rich neighborhood than what he would have spent if he was living in the vicinity of the poor people. Thus, even the lower income families will be spending more on consumption if they are in constant contact with rich families and friends, then those richer families who are surrounded by poor friends, relations and neighbors. Duesenberry calls this phenomenon the Demonstration Effect. As individuals come into contact with superior goods and superior patterns of living, the urge and impulse to increase their own consumption becomes more intense.


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