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Behavioral Indifference Curves

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  • John Komlos

Abstract

According to the endowment effect there is some discomfort associated with giving up a good, that is to say, we are willing to give up something only if the price is greater than the price we are willing to pay for it. This implies that the indifference curves should designate a reference point at the current level of consumption. Such indifference maps are kinked at the current level of consumption. The kinks in the curves imply that the utility function is not differentiable everywhere and the budget constraint does not always have a unique tangent with an indifference curve. Thus, price changes may not bring about changes in consumption which may be the reason for the frequent stickiness of prices, wages and interest rates. We also discuss a multiple period example in which the indifference map shifts as the reference point shifts implying that the curves cross over time even though tastes do not change.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 4856.

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Date of creation: 2014
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Handle: RePEc:ces:ceswps:_4856

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Keywords: behavioral economics; indifference curves; endowment effect; reference state; gain and loss equivalence; stickiness of prices and wages;

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  1. Knetsch, Jack L, 1989. "The Endowment Effect and Evidence of Nonreversible Indifference Curves," American Economic Review, American Economic Association, American Economic Association, vol. 79(5), pages 1277-84, December.
  2. Dennis W. Carlton, 1986. "The Rigidity of Prices," NBER Working Papers 1813, National Bureau of Economic Research, Inc.
  3. Knetsch Jack L. & Riyanto Yohanes E. & Zong Jichuan, 2012. "Gain and Loss Domains and the Choice of Welfare Measure of Positive and Negative Changes," Journal of Benefit-Cost Analysis, De Gruyter, De Gruyter, vol. 3(4), pages 1-20, December.
  4. Andersen, Torben M., 1998. "Persistency in sticky price models," European Economic Review, Elsevier, Elsevier, vol. 42(3-5), pages 593-603, May.
  5. Ausubel, Lawrence M, 1991. "The Failure of Competition in the Credit Card Market," American Economic Review, American Economic Association, American Economic Association, vol. 81(1), pages 50-81, March.
  6. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard H, 1990. "Experimental Tests of the Endowment Effect and the Coase Theorem," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(6), pages 1325-48, December.
  7. Knetsch, Jack L & Sinden, J A, 1984. "Willingness to Pay and Compensation Demanded: Experimental Evidence of an Unexpected Disparity in Measures of Value," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 99(3), pages 507-21, August.
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