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Consumption Paths under Prospect Utility in an Optimal Growth Model

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  • Reto Foellmi
  • Rina Rosenblatt-Wisch
  • Klaus Reiner Schenk-Hoppé

Abstract

This paper studies the Cass-Koopmans-Ramsey model of optimal economic growth in the presence of loss aversion and habit formation. The representative agent's preferences for consumption can be gradually varied between the standard constant intertemporal elasticity of substitution (CIES) case and Kahneman and Tversky's prospect utility. We find that the transitional dynamics of optimal consumption paths differ distinctly from the standard model, in particular consumption smoothing is more pronounced. We also show that prospect utility can cause the economy to remain in a steady state with low consumption and low capital.

Suggested Citation

  • Reto Foellmi & Rina Rosenblatt-Wisch & Klaus Reiner Schenk-Hoppé, 2010. "Consumption Paths under Prospect Utility in an Optimal Growth Model," Diskussionsschriften dp1010, Universitaet Bern, Departement Volkswirtschaft.
  • Handle: RePEc:ube:dpvwib:dp1010
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    References listed on IDEAS

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    1. Croix, David de la & Michel, Philippe, 1999. "Optimal growth when tastes are inherited," Journal of Economic Dynamics and Control, Elsevier, pages 519-537.
    2. Francisco Alvarez-Cuadrado & Goncalo Monteiro & Stephen J. Turnovsky, 2004. "Habit Formation, Catching Up with the Joneses, and Economic Growth," Journal of Economic Growth, Springer, vol. 9(1), pages 47-80, March.
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    Citations

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    Cited by:

    1. Femke De Keulenaer & Jan-Emmanuel De Neve & Georgios Kavetsos & Michael I. Norton & Bert Van Landeghem & George W. Ward, 2014. "The Asymmetric Experience of Positive and Negative Economic Growth: Global Evidence Using Subjective Well-Being Data," CEP Discussion Papers dp1304, Centre for Economic Performance, LSE.
    2. Curatola, Giuliano, 2015. "Loss aversion, habit formation and the term structures of equity and interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 53(C), pages 103-122.
    3. Rosenblatt-Wisch, Rina, 2008. "Loss aversion in aggregate macroeconomic time series," European Economic Review, Elsevier, vol. 52(7), pages 1140-1159, October.
    4. Branger, Nicole & Grüning, Patrick & Schlag, Christian, 2016. "Commodities, financialization, and heterogeneous agents," SAFE Working Paper Series 131 [rev.], Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    5. Keith Blackburn & David Chivers, 2015. "Fearing the worst: the importance of uncertainty for inequality," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 60(2), pages 345-370, October.
    6. repec:eee:quaeco:v:66:y:2017:i:c:p:345-358 is not listed on IDEAS
    7. Lena Dräger & Jan-Oliver Menz & Ulrich Fritsche, 2014. "Perceived inflation under loss aversion," Applied Economics, Taylor & Francis Journals, vol. 46(3), pages 282-293, January.

    More about this item

    Keywords

    Ramsey growth model; prospect theory; loss aversion; optimal consumption;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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