The Welfare Economics of Reference Dependence

Daniel Reck and Arthur Seibold

No 9999, CESifo Working Paper Series from CESifo

Abstract: Empirical evidence suggests that individuals often evaluate options relative to a reference point, especially seeking to avoid losses. In this paper, we provide the first welfare analysis under reference-dependent preferences. We decompose the welfare impact of changes in reference points and prices into direct and behavioral effects, and describe how these effects depend on whether reference dependence reflects a bias or a normative preference. In a simple model of loss aversion grounded in common empirical findings, we find that lowering reference points robustly improves welfare, while the welfare effect of a price change depends critically on normative judgments. We also derive sufficient statistics characterizations of the welfare effects of changing reference points and prices. We illustrate these theoretical findings with an empirical application to reference dependence exhibited in German workers’ retirement decisions. Both simulation and sufficient statistics results suggest positive welfare effects of increasing the Normal Retirement Age, but ambiguous effects of financial incentives to postpone retirement. Finally, we study how adopting alternative models of reference dependent preferences modifies key welfare effects.

Keywords: reference-dependent preferences; loss aversion; welfare; pension reform (search for similar items in EconPapers)
JEL-codes: D60 D91 H55 J26 (search for similar items in EconPapers)
Date: 2022
New Economics Papers: this item is included in nep-age, nep-cbe, nep-lma, nep-pbe, nep-pub and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.cesifo.org/DocDL/cesifo1_wp9999.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 503 Service Unavailable

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_9999

Access Statistics for this paper

More papers in CESifo Working Paper Series from CESifo Contact information at EDIRC.
Bibliographic data for series maintained by Klaus Wohlrabe ().