From Neighborhoods to Nations: The Economics of Social Interactions

By Yannis M. Ioannides | Go to book overview

CHAPTER 2
Social Interactions
Theory and Empirics

2.1 INTRODUCTION

This chapter addresses the role of the social context in individual decisions. Many important markets continue to coexist with nonmarket arrangements. Social interactions, that is, nonmarket interactions, are ubiquitous, and social institutions do matter to an extent not fully appreciated by economics (Arrow 2009). Understanding the social consequences of economic decisions requires that we acknowledge their social context. With economics increasingly venturing into the traditional realms of other social sciences, recognizing the importance of social interactions can be particularly helpful in understanding a diverse set of phenomena, from obesity and cigarette smoking to economic inequality.

In the canonical case of individual decision making when goods and services are procured from markets, individuals are assumed to choose quantities of goods and services to maximize utility subject to a budget constraint. The basic model has been extended to allow for externalities, that is, direct effects from an individual to another that do not involve market transactions. In the presence of externalities, market prices may not reflect the full social value of the respective goods and services. For example, my neighbor’s playing loud music bothers me, and there is no direct market-mediated way for my unhappiness to be transmitted to him and hence to affect his behavior. This might prompt me to leave the area and perhaps to move near people whom I think are less likely to engage in behaviors that I find unpleasant or perhaps who are like me. When I rent a particular apartment in a multiunit complex or buy a home in a suburban subdivision, I can expect that my daily life will be affected by the behavior of my neighbors as they, too, go about their daily lives. Such effects are “bundled” with my choice of residence. My own actions will in turn affect the welfare and perhaps actions of my neighbors who are sensitive to them.

The part of the marginal value of a good that is due to its being appreciated by those consuming it is equal to the marginal cost to them of acquiring it. In competitive markets, it is also equal to the cost of producing an additional unit. Yet, an additional unit of the good may have adverse effects on some

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