RELATIVE INCOME HYPOTHESIS # Ratchet & Demonstration Effect # Malayalam Explanation.

Introduction

In this tutorial, we will explore the Relative Income Hypothesis, focusing on the Ratchet Effect and Demonstration Effect as explained in the video by Priya Hariprasad. Understanding these concepts helps in grasping how individuals' consumption patterns and social behaviors can be influenced by their income relative to others.

Step 1: Understand the Relative Income Hypothesis

• The Relative Income Hypothesis suggests that individuals derive utility not just from their absolute income but also from their income in relation to others.
• Key points to consider:
  • People compare their income with their peers.
  • Consumption choices are influenced by societal standards and the incomes of those around them.

Step 2: Explore the Ratchet Effect

• The Ratchet Effect describes how an individual’s consumption levels can be "locked in" once they reach a certain income threshold.
• Important aspects:
  • When income rises, individuals tend to increase their consumption.
  • If income falls, they may not reduce their consumption to the previous level due to psychological factors and societal pressure.
• Practical tip: Be aware of lifestyle inflation; as your income increases, avoid overcommitting to higher expenditures.

Step 3: Examine the Demonstration Effect

• The Demonstration Effect occurs when individuals adjust their consumption patterns by observing others' consumption.
• Key points to note:
  • People are influenced by the spending habits of peers, leading to changes in their own consumption.
  • This effect can create societal trends or pressures to conform to certain lifestyles.
• Practical advice: Recognize the social influences on spending; strive for personal financial goals rather than following trends.

Step 4: Analyze Real-World Applications

• These concepts can be observed in various scenarios:
  • Marketing Strategies: Companies often use social proof to influence consumer behavior.
  • Financial Planning: Understanding these effects can help individuals make better financial choices and avoid unnecessary debt.
• Common pitfall: Failing to account for the influence of peers can lead to overspending and financial strain.

Conclusion

The Relative Income Hypothesis, along with the Ratchet and Demonstration Effects, plays a significant role in shaping consumer behavior. By acknowledging how relative income impacts our choices, we can make more informed financial decisions. Moving forward, focus on your personal financial goals and be mindful of external influences on your spending habits.