Reference-Dependent Consumption Plans

We develop a rational dynamic model in which people are loss averse over changes in beliefs about present and future consumption. Because changes in wealth are news about future consumption, preferences over money are reference-dependent. If news resonates more when about imminent consumption than w...

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Bibliographic Details
Published in:The American economic review 2009-06, Vol.99 (3), p.909-936
Main Authors: Kőszegi, Botond, Rabin, Matthew
Format: Article
Language:English
Subjects:
Consumer economics
Consumption
Consumption theory
Decision making
Determinism
Economics
Expected utility
Financial risk
Intuition
Loss aversion
Lotteries
Marginal utility
Microeconomics
Modeling
Preferences
Risk aversion
Savings
Studies
Wealth
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Summary:We develop a rational dynamic model in which people are loss averse over changes in beliefs about present and future consumption. Because changes in wealth are news about future consumption, preferences over money are reference-dependent. If news resonates more when about imminent consumption than when about future consumption, a decision maker might (to generate pleasant surprises) overconsume early relative to the optimal committed plan, increase immediate consumption following surprise wealth increases, and delay decreasing consumption following surprise losses. Since higher wealth mitigates the effect of bad news, people exhibit an unambiguous first-order precautionary-savings motive.
ISSN:0002-8282
1944-7981
DOI:10.1257/aer.99.3.909