Importance of "Relative" Terms rather than "Absolute" Terms

Economics has long been considered only 'absolute' term. In most standard analysis, utility is determined by the level of own consumption and job matching is occurred according to the level of absolute wage. However, in reality, there are many occasions where relative terms play important role as Kahneman and Tversky pointed out. Depending on the reference point, same absolute term can be interpreted differently. If I have so many wealthy friends, then my income as a graduate student is tiny. However, if most of my friends are still in university, my income as graduate student is considerable. That is, if reference point is decided by people around me then important thing is where I stand, not the amount I have.

I went to a talk by Mounir Karadja today and he gave such an interesting story why Sweden can sustain their social welfare system. According to a 2012 OECD report, the country had the second-highest public social spending as a percentage of its GDP after France, which means that this country has one of the most highly developed welfare states. According to his, one of the reasons is that many of people underestimate their relative income. (Relative income here means where you stand in the country's income distribution.) If they are informed their actual relative position and it was higher than their guess, they tend to support conservative party more. That is, Swedish people's guess about relative income could play a role in their political preferences of supporting welfare systems.

Another interesting piece is by Bertrand, Kastenica, and Pan. They discuss the role of social norm "Husband should earn more than wife" on many economic variables such as marriage, labor market participation, divorce rate and satisfaction in the marriage. Here as well what matters is 'relative' income in the household. Relative income here is defined by men's earning divided by women's earning plus men's earning. If this relative income is less than half, then social norm is violated. In this case, marriage rate is decreased, women's labor market participation is decreased (woman don't want to threat her husband), divorce rate is increased and satisfaction in marriage is lower. I enjoyed reading this paper very much not only because I found it interesting to incorporate the role of social norm in economics but also because the way they thought about income distribution in households (i.e.relative income) was interesting.

In sum, I think relative terms are very important in many economic decisions. Below are some references.

"How Elastic are Preferences for Redistribution? Evidence from Randomized Survey Experiments" March 2013 (I. Kuziemko, M. Norton, S. Stantcheva and E. Saez), Revise and Resubmit, American Economic Review (also released as NBER working paper 18865)

"Inequality at Work: The Effect of Peer Salaries on Job Satisfaction." (David Card, Alexandre Mas, Enrico Moretti, and Emmanuel Saez) NBER Working Paper, No. 16396, September 2010.

"Relative income shocks, beliefs and political preferences: Evidence from a randomized survey experiment" (Mounir Karadja et al.)