Development Economics

ECO 311A

Course Proposer: Dr Debayan Pakrashi

Outline of this lecture

z Greed
y Examples.
y What is meant by greed.
y Socialism and greed.

z Greed and groups.

z Options for modeling greed:

y Stand-alone consumption.
y Relative consumption.
Keeping up with the Joneses
 Greed
z `It is not from the benevolence of the butcher, the brewer, or
the baker that we expect our dinner, but from their regard to
their own interest'. (Adam Smith, 1776)

z Homo Economicus is a rationally greedy individual.

y Greed is morally ambivalent: the greedy person judges only on the
basis of what she gets out of it, not anything else.
Examples of this reasoning

z 1. Cultural inhibitions against eating cows in India? The

standard explanation of the economists: this prevents people
when times are bad from eating their productive future
capacity.
z 2. Cannibalism in meso-America in pre-Columbian times? The
standard explanation of the historical materialists amongst
anthropologists: other sources of protein were scarce and
hence they were just being efficient with the available stock of
protein.
z 3. Constantly changing European rules on the food labeling of
Australian beef? Standard answer: an attempt by the
European agricultural lobby to prevent competition by
Australian beef and hence a means of preserving income.
Harcourt
Evidence for this assumption..

z 1. Merely a week after the Russian tsar Peter

the Great imposed a heavy tax on wearing
beards in 1698, there was barely a whisker to
be seen in his vicinity.
z 2. When my local shop wants to sell
something quickly, it puts it on sale.
z 3. When contemplating the educational choice
of our children, many of us want them to do
something they can earn at least a minimal
level of income with.
Harcourt
More evidence….

z 4. One the main activities on the internet is

the use of search engines for the cheapest
airline tickets.
z 5. Within six months after introducing a small
fee for plastic bags at supermarkets in Ireland,
the volume of plastic bags dropped 90%.

Harcourt
Evidence continued…

z 6. When the European nations subsidised their

farmers by export subsidies, the borders between
countries saw the phenomenon of trucks laden with
agricultural produce crossing the same border in
different directions dozens of times per day, simply to
claim the same subsidy many times over.
z 7. The display of materialist behaviour all around us
every day.

Harcourt
More examples

z Discrimination against migrants in Chinese

cities.

z Advertising in shopping malls.

z Budget wars inside major organisations

y Hiding money left over.
y Expanding the scope of subgroups.
y Coordination (gossip) to undermine the validity of
budget claims of others.
But what is greed?

z Greed is at heart a wish for control

y Possession of material resources by definition
means control over those resources: one
determines who consumes and uses those
resources.
y In reality, a lot of actual consuming is not done by
the possessor of the goods. Normally, a lot of
possessions become ‘shared’, but do so according
to the will of the controller.
y There are other ways of gaining control rather
than possession (which is a societal-accepted form
of control): becoming a boss is another way.
Greed and groups

z Hierarchies are the main vehicles for greed and being

top of a hierarchy a key expression of greed.
z But greed operates in each organisation, including
reciprocal ones: an incessant, never ending striving
for more resources.

z Greed can be a motivation to form new groups with

which to more successfully gain advantage:
y Reciprocal groups that corner a market (unions, medical
associations, some ethnicities).
y Hierarchical groups with which to take over an organisation
(secret service, armed groups).
Modelling greed

z The question here is how exactly greed might

influence people’s behaviour, i.e. The
functional form of greed in the utility function.

z Classic models of greed.

z Extended models:
y Rank-seeking and status seeking
y Internal reference groups.
The classic model of greed

z U(yit)=U(c(yit))

y Hence individual utility is only affected by income

through the effect of income on own consumption
in the period of consumption.
y Thus people really only care about own
consumption. They might smooth consumption
and trade it off against other goods consumed
personally.
y This is the dominant model in macro-economics,
micro-economics, game theory, etc.
Reflections on the classic
model of greed

z Whenever you see a ‘simple model’, ask yourself what, if it is

true, it would mean. That will give you a clearer idea of the
real assumptions.
y Do people really consume alone?
y Is the enjoyment we get out of a higher income truly
divorced of what others consume (friends, family, rivals,
enemies)?
y Introspection: does it capture the reasons I want more
money?
y Do I really get no enjoyment out of thinking about income
at other moments?
Hence

z Even if we forget about non-material motives

for a while, a large part of the utility value of
more income is not consumption.
y We also care about whether our income is bigger
than that of others.
y We get anticipatory utility out of imagining being
rich tomorrow.
y We care whether our income is bigger than
yesterday.
Evidence on the role of status

Source: Mujcic and Frijters (2011)

Quick quiz (Solnick and Hemenway (1998))

z A: Your current yearly income is $50,000;

others earn $25,000.
z B: Your current yearly income is $100,000;
others earn $200,000.
z
z It is specified that “others” refers to the
average of other people in the society, and
emphasised that “prices are what they are
currently and prices (the purchasing power of
money) are the same in States A and B”.
Findings from such studies....

z Males, young individuals and those from

wealthier families are more status oriented.
Strong evidence for the existence of status
effects (no one in the data consistently
chooses the situation with highest absolute
income).
Evidence on happiness over time:
happiness in the US

3 35000

2.5 30000

Real Income Per Capita

Average Happiness

25000
2
20000
1.5
15000
1
Happiness Real Income Per Capita 10000
0.5 5000

0 0
1973 1977 1978 1982 1986 1990 1994 2000 2004
Year
Other rich countries?
4

3.5

3
Average Life Satisfaction

2.5

1.5
UK France Germany Italy Netherlands
1

0.5

0
1973 1977 1980 1983 1986 1988 1990 1993 1996 2000 2004
Year
 7 8000
6.5

Growing countries:
6 7000
5.5
5
Life Satisfaction RealIncome 6000

Real Income (DM)

East-Germany?

Life Satisfaction
4.5
4
3.5 5000
3
2.5
4000
2
1.5
1 3000

0.5
0 2000
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Year

FIGURE 2: Life Satisfaction and Real Monthly Income in Russia, 1994-2001

1.8 Life Satisfaction 7000

Real Monthly Income

1.6
6000

1.4
Life Satisfaction (0-1)

5000
1.2
and Russia?

Real Monthy Income

1 4000

0.8 3000

0.6
2000
0.4

1000
0.2

0 0
1994 1995 1996 Year 1998 2000 2001
Easterlin Paradox

Status seeking

Adaptation
Models of status

z R equals relative income or rank of an income

in a society.
y Which group is someone ranking themselves
against?
y How does this differ from the classic model?
Example 1: basic needs get satisfied,
what remains is vanity
U t  1 ln( yt )   2 ln( yt / yt* )  Z t' yt individual Income,
y*t aggregate income
Happiness

Relationship within a
country at some time

Country t2
Country t1

Country t0
Relationship across
time in a country

0 Log Income
hence

z Happiness does increase for poor countries

that get richer, but remains stable for rich
countries getting even richer.
z A status race explains this: individuals evaluate
their consumption relative to others.
y Note that this fits the idea of dominance even
better than the presumption that people maximise
wealth; maximising relative wealth is all about
doing better than others.
 Sub-example: adaptation is like a
moving reference position

U it  1 ln( yit )   2 ln( yit / y *t )

y *t  ( yit 1 ) ( yit  2 ) ( yit 3 )1 

U it  1 ln( yit )   2 [ln( yit )   ln( yit 1 )   ln( yit  2 )  (1     ) ln( yit 3 )]
Models of Internal reference points

z Y* equals reference income that depends on

past own income.
y Exact functional form?
y How does this differ from the classic model?
Example model of what this means for
choice and policy: a costly status race

U it  1 ln( yit )   2 ln( yit / yt )   ln(T  yit / wt )

Reference groups and the self

z A: The income in the first 10 years of your

working life is $50,000; it is $100,000 the next
10 years of your working life.
z B: The income in the first 10 years of your
working life is $100,000; it is $50,000 the next
10 years of your working life.

y Which do you choose?

Findings

z Nearly everyone, including students from big

overseas universities, choose option A.
z But the discounted value of B is higher.
z The reason you choose A is because you know
you will compare the value of your income to
the income level you have grown used to.
z So you dont just compare yourself to others,
but also to yourself in the past. And at some
level, you know this.
Models of power plays
z We quickly introduce the Becker 1983 model of
political rent-seeking, which is quite in line with
the ‘main game’ thinking in the textbook.

z Examples relevant to Becker (1983) “A theory

of competition among pressure groups for
political influence” are abound in industries
which lobby for tax benefits, national
governments competing for aid, local
governments lobbying for a larger share of the
budget, etc.
The equilibrium

z Political equilibrium depends on the

• efficiency of each group in producing pressure,

• the effect of additional pressure on their
influence,
• the number of persons in different groups, and
• the deadweight cost of taxes and subsidies.
The Structure of the Model
z Individuals belonging to particular political groups
use political influence to enhance the well-being
of their members (they bargain as a group for
political favours).
z There is a competition for political favours
between political groups.
z Competition among these pressure groups for
political influence determines the equilibrium
structure of taxes, subsidies, and other political
favours.
z Ultimately, the governments favour the politically
powerful.
z Political influence is not fixed, but can be
expanded by expenditures of time and money
on campaign contributions, political
advertising.
z Political equilibrium has the property that all
groups maximize their incomes by spending
their optimal amount on political pressure,
given the productivity of their expenditures,
and the behaviour of other groups.
z Each group behave under the assumption that
expenditures by other groups are unaffected
by changes in its own expenditures.
Examples of such political competition

The analysis of competition among pressure

groups, without the introduction of social
welfare functions or a benevolent government,
explains expenditures on defense and other
public goods, taxes on pollution, and other
government activities that raise efficiency,
even when some groups are hurt by these
activities.
 The interdependence of the two groups

z Taxes and subsidies are related by the identity

between revenue and expenditures.

z The total amount raised from taxes, including

hidden taxes like inflation, equals the total
amount available for subsidies, including
hidden subsidies like restrictions on entry into
an industry (the budget condition).
 The Assumptions of the Model

z Groups compete within the context of rules

that translate expenditures on political
pressure into political influence and access to
political resources.
z To simplify the analysis without any
significant loss in generality, utility of each
person is measured by his real full income,
and full incomes can be added to measure
aggregate income or aggregate output.
z Assume initially only two homogeneous groups
in the society, s and t.

z Since identical persons must have the same

income, Z and Z can measure the full income of
0
s t
0

each member of s and t prior to government

redistribution, and

z Z s and Z t can measure their incomes after

redistribution.
z So, redistribution of income due to taxes and
subsidies will result in the final income,
z Income gain due to subsidies will be

Rs  Z s  Z s0

z Income loss due to taxation will then be

Rt  Z t0  Z t
 The distribution among the political groups

z All political activities that raise the income of

a group will be considered a subsidy to that
group, and all activities that lower incomes will
be considered a tax. The amount raised by all
taxes on t and subsidies given to all in the
group can be written as

ns G ( Rs )  S  nt F ( Rt )
 Political systems and pressure groups

z All political systems, including dictatorial as

well as democratic systems, have been subject
to pressures from special interest groups that
try to use influence to enhance their welfare.

z Different political systems translate the

activities of pressure groups into political
influence.
 Influence Functions
z “Influence functions,” relate subsidies and
taxes to the pressures exerted by all groups
and to other variables.
z The amount raised in taxes on t is determined
by an influence function that depends on the
pressure (p) exerted by s and t and other
variables (x):
nt F ( Rt )   I t ( ps , pt , x)
z Similarly, the amount available to subsidize s
is determined by an influence function that
also depends on political pressures and other
variables:

ns G ( Rs )  I s ( ps , pt , x)
 The Political Budget
ns G ( Rs )  S  nt F ( Rt )

The political budget equation then implies that these influence

functions cannot be independent because increased influence of s
that raises its subsidy must be financed by increased taxes on t, and
hence must lower the influence of t.

The political budget can then be rewritten as

nt F ( Rt )  I t  nsG(Rs )  I s
The budget equation can then be rewritten as

Is  It  0

Equality between the amount raised in taxes and the

amount spent on subsidies implies that aggregate
influence is zero: increased influence of some groups
decreases the influence of others by equal amounts.
Therefore, the political game modelled in this paper
is zero-sum in influence and negative-sum in taxes
and subsidies because of deadweight costs.
 Problems based on this lecture

z Problems based on this lecture

z status seeking model

z political competition model

will be dealt with in the next lecture along with

the corruption lecture.