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Intertemporal Choice under Habit Formation

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  • Ernst Fehr
  • Peter K. Zych

Abstract

Many of the most important choices in people's lives have an inter-temporal dimension, i.e., these choices are associated with a flow of benefits or costs that accrue in the future. In addition, such choices are frequently habit-forming. Yet, little is known about habit-forming inter-temporal choice behavior. This paper reports the results of an inter-temporal choice experiment with habit-formation. Subjects' choices deviate systematically from individually optimal decisions in the direction of over-consumption. This over-consumption is partly driven by loss avoidance, comparable to a real life situation in which addicted people consume addictive substances only in order to overpower withdrawal symptoms. Our results thus reject the theory of rational addiction.

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Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 043.

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Handle: RePEc:zur:iewwpx:043

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Keywords: Inter-temporal Choice; Habit Formation; Addiction; Irrational Behaviour; Excess Consumption;

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  1. Becker, Gary S & Murphy, Kevin M, 1988. "A Theory of Rational Addiction," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(4), pages 675-700, August.
  2. Tversky, Amos & Kahneman, Daniel, 1991. "Loss Aversion in Riskless Choice: A Reference-Dependent Model," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 106(4), pages 1039-61, November.
  3. Ernst Fehr & Peter K. Zych, 2003. "Do Addicts Behave Rationally?," Experimental, EconWPA 0305002, EconWPA.
  4. Martin Browning & Annamaria Lusardi, 1996. "Household Saving: Micro Theories and Micro Facts," Discussion Papers 96-01, University of Copenhagen. Department of Economics.
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Cited by:
  1. Ernst Fehr & Lorenz Goette, 2000. "How Robust are Nominal Wage Rigidities?," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 0071, Econometric Society.

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