An Incentive Model of the Effect of Parental Income on Children

Economists explain the positive relationship between parental income and children’s outcomes using an investment model. Building on work in psychology and sociology, this paper emphasizes the importance of child‐rearing practices, which vary with income. I argue that parents’ ability to mold their children’s behavior through pecuniary incentives is limited at low incomes, leading to lower outcomes and increased reliance on nonpecuniary mechanisms such as corporal punishment. My model generates a positive relationship between parental income and children’s outcomes especially at low incomes and endogenously produces a relationship between parental income and child‐rearing practices. Empirical work confirms these implications.