The economic rationale of friendships

Alex Setiawan


February 27th, 2015

Alex Setiawan offers an economic perspective on the importance of friendships.

University—a fresh start, and a new beginning. For many of us, especially first year students, it represents the next chapter in our lives. University gives us all the opportunity to experience new things, such as independence from our parents. Along this journey to adulthood, we will inevitably make new friends. For some, making friends seems very natural, and for others not so much.

However, have you ever wondered why we seek friends? Why are you friends with the people you are with now? You may not know it, but our brains generally make rational decisions in choosing our friends. Welcome to the economics of friendships.

Economic theory suggests that all of us, as rational individuals, make optimal choices in order to satisfy our wants, thus maximising both our utility and happiness. In that regard, we seek friends because, as social creatures, interacting with others makes us happy and fulfilled. Unfortunately, we can become good friends with only a few people as we have only a limited amount of resources—in this case, time. In addition, making friends can be a costly exercise—the person whom you want to be friends with may not want to become friends with you.

Faced by these challenges, our consciousness develops an interesting way to ensure that we can make friends—by interacting with others with similar characteristics. All other things being equal, people who share the same background and interests as us are more likely to be accepting of who we are, and to reciprocate our efforts to become friends. This phenomenon, called homophily, has been observed by many economists worldwide.[1] In retrospect, it may make more sense if we don’t join a billion clubs at O-week; just the ones that pique our interest will do. In friendships, quality matters much more than quantity. However, we can learn new things from people who are fundamentally different from us, and there is no reason why we can’t be friends with them as well.

Apart from bringing happiness, our friendship networks can provide us with collateral economic benefits in a wide range of activities. As an example, consider the current labour market conditions for Australian youth. As of July 2014, 14.1% of people aged 15–24 are unemployed; 300,000 of young people, like you and me, without a job.[2] In an increasingly competitive world, every advantage counts and our networks may prove to be the difference. Your friends who do have jobs can vouch for you to fill new job openings and thus get you off the unemployment path.

Friends can also give crucial input when we decide important matters, such as buying our first cars. Aside from the very rich, most of us would have to settle for a used car. Unfortunately, the used car market is littered mostly with bad cars, dubbed ‘lemons’, or good ones, which are nicknamed ‘plums’. This is the classic economics dilemma of asymmetric information,[3] where the dealer generally knows more than we do about the condition of the cars. Having a friend who is knowledgeable about cars will improve our chances to pick a ‘plum’ for a reasonable price.

Friends may also motivate us to improve our scores. A recent study by Russian economists shows that having a regular study partner acts as a sufficient incentive for students to achieve a higher GPA at university.[4]

Although economists like the idea of putting a value on things, friends themselves, or at least true friends, are priceless. They are always there for you, whether you have just broken up with your girlfriend or boyfriend, failed a uni subject or are just having a bad day. They don’t need gifts or favours to be your friend. We want to be their friends, and they want to be ours without any conditions whatsoever. Of course, true friends are also hard to make.

Over our lifetime, we will make a lot of friends. It’s certain that some of them will stick with us, while we will lose contact with others. As we get older, we truly cherish friends who have been with us in our best times, and in our worst. It could be a friend from childhood, or it could be the person you meet in a club at university.

University is the perfect place where friendships are made that will last our whole lifetime. How we choose our friends is entirely up to us. For first-years, the early months of university can be daunting as you may be unfamiliar with your surroundings, but it will get better as you gradually get used to university life and make some new friends. The whole ESSA team and I wish all of you the very best for your studies in the years to come.

[1] Sergio Currarini, Matthew O Jackson and Paolo Pin, ‘An Economic Model of Friendship: Homophily, Minorities, and Segregation’ (2009) 77(4) Econometrica 1003.

[2] Brotherhood of St Laurence, ‘Generation Jobless: more than half a million young people underemployed or unemployed’ (Media Release, 1 September 2014).

[3] George A Akerlof, ‘The Market for “Lemons”: Quality Uncertainty and the Market Mechanism’ (1970) 84(3) The Quarterly Journal of Economics 488.

[4] Oleg Poldin, Dilyara Valeeva and Maria Yudkevich, ‘How Social Ties Affect Peer-group Effects: A Case of University Students’ (15/SOC/2013, National Research University Higher School of Economics, 2013).

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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