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A theory of reference point formation

Author

Listed:
  • Özgür Kıbrıs

    (Sabancı University)

  • Yusufcan Masatlioglu

    (University of Maryland)

  • Elchin Suleymanov

    (Purdue University)

Abstract

We introduce a model of reference-dependent choice where the reference point is endogenously determined through maximization of a conspicuity ranking. This subjective ranking captures how prominent or eye-catching the alternatives are relative to one another. The most conspicuous alternative in a choice set serves as the reference point and in turn determines the reference-dependent utility function the decision maker maximizes to make a choice. We show that this conspicuity based endogenous reference model (CER) is characterized by an intuitive and simple behavioral postulate, called the Single Reversal, and we discuss how choice data can be used to reveal information about CER’s parameters. We additionally analyze special cases where a reference-free utility function, combined with psychological constraints, is used to make reference-dependent choices.

Suggested Citation

  • Özgür Kıbrıs & Yusufcan Masatlioglu & Elchin Suleymanov, 2023. "A theory of reference point formation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 75(1), pages 137-166, January.
    • Handle: RePEc:spr:joecth:v:75:y:2023:i:1:d:10.1007_s00199-021-01392-3
    DOI: 10.1007/s00199-021-01392-3
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    More about this item

    Keywords

    Conspicuity; Reference-Dependence; Reference point formation; Revealed preference; Psychological constraints; Choice reversal;
    All these keywords.

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory

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