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An Extended Theory of Rational Addiction

Federico Perali (), Luca Piccoli and Knut R. Wangen ()
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Knut R. Wangen: University of Oslo

No 69, DEA Working Papers from Universitat de les Illes Balears, Departament d'Economía Aplicada

Abstract: This study extends the Rational Addiction theory by introducing an endogenous discounting of future utilities. The discount rate depends on habits accumulation over time which occur because of the repeated consumption of an addictive good. The endogeneity of the discount rate affects consumption decisions via a habits dependent rate of time preference and discloses a patience-dependence trade off. The existence of a steady state in which habits do not grow and its optimality are proven. Local stability properties of the steady state reveal that the equilibrium can be a saddle node, implying smooth convergence to the steady state, but also a stable or unstable focus, potentially predicting real world behaviors as binge drinking or extreme addiction states that may drive to death. The stability of the steady state mostly depend on the habit formation process, suggesting that heterogeneity in habit formation may be a key component to explain heterogeneity in time preferences.

Keywords: habit formation; addiction; endogenous discounting; time inconsistency (search for similar items in EconPapers)
JEL-codes: D11 I12 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-mic
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