Expenditure cascades are changes in purchasing and consumption behaviour which ripple through the levels of income in response to changes in income inequality.

Example

During the late 1900s and early 2000s, income inequality in the United States

United States

The United States of America is a federal constitutional republic comprising fifty states and a federal district...

 rose dramatically. Expenditure cascades occurred. During the 1980s, the income-tax structure was altered to favor top earners in regards to after-tax purchasing power

Purchasing power

Purchasing power is the number of goods/services that can be purchased with a unit of currency. For example, if you had taken one dollar to a store in the 1950s, you would have been able to buy a greater number of items than you would today, indicating that you would have had a greater purchasing...

.

Positional Externalities

Expenditure cascades employ Positional Externalities which may relate differently than other types of externalities. When a new purchase changes the context within which an existing positional good

Positional good

In economics, positional goods are products and services whose value is mostly a function of their ranking in desirability by others, in comparison to substitutes. The extent to which a good's value depends on such a ranking is referred to as its positionality...

 is evaluated, a positional externality occurs. In situations where a good is upgraded and becomes a popular item to own, that good becomes a positional externality. It has changed the context within which that good exists. Positional Externalities also have an effect on an individual’s happiness. When a person focuses on the haves and have-nots of those around him, he realizes the items that he does not own relative to the others in his class system. This realization leads to increased unhappiness about his position in life in terms of items owned. Robert H. Frank

Robert H. Frank

Robert H. Frank is the Henrietta Johnson Louis Professor of Management and a Professor of Economics at the Samuel Curtis Johnson Graduate School of Management at Cornell University. He contributes to the "Economic View" column, which appears every fifth Sunday in The New York Times.-Career:Frank...

 cites an experiment that shows people choose a world in which they own a larger home than everyone else over having larger homes for everyone yet a smaller home than his neighbors. Frank concludes that people will give up absolute consumption in order to obtain a better relative position. Expenditure cascades are triggered by consumption

Consumption (economics)

Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...

. The consumption of the wealthy triggers increased spending in the class directly below them and the chain continues down to the bottom. This is a dangerous reaction for those at the bottom who have little disposable income originally and even less after they attempt to keep up with others spending habits.

Possible Solutions to the Problem of Positional Externalities

Frank suggests that a progressive income tax could remedy the dilemma posed by Positional Externalities. By increasing the progressivity of the current tax structure, the wealthy would pay a larger share of taxes. Simultaneously, the poor and middle class would pay taxes that would be more equitable to their income. A result would be an equal playing field for all the classes. Frank uses the housing market as an example. He states that people at the top should save their earning and spend less on housing. In turn, their savings would alter the context that influences housing expenditures of people directly below top earners. This would result in a reverse expenditure cascade that would encourage higher savings. The fact that, in 2005, Americans had a negative savings rate, further proves the need for incentives to save money rather than increasing relative spending. The key to creating a genuine impact on spending and saving habits is the collective effort of everyone invested in the economy to cut back on spending. Should a deficit continue, the poor and middle classes will suffer disproportionately to the top earners.