The impact of group identity on experimental markets with externalities

Existing evidence demonstrates that the degree of social homogeneity in a society correlates with various economic indicators. Using experimental techniques, we establish the causal impact of social distance on socially responsible behavior, market prices, market efficiency and income inequality. We develop an experimental market where low-cost production generates a negative externality to a third party, while high-cost production eliminates the externality. We compare behavior in groups varying whether the third party shares a common identity with buyers and sellers (in-group condition) or not (out-group condition). Our findings indicate that socially responsible behavior is generally robust across our treatments. However, boosting group identity improves economic welfare indicators, as it leads to a striking reduction of economic inequality through changes in market price levels and improves market efficiency. Overall, our experiment shows that the social environment of market interactions matters a great deal and has significant implications for the design of institutions.