Working Paper: NBER ID: w31381
Authors: Daniel Reck; Arthur Seibold
Abstract: Empirical evidence suggests that individuals often evaluate options relative to a reference point, especially seeking to avoid losses. We undertake the first welfare analysis under reference-dependent preferences. We characterize the welfare impact of changes in reference points and prices, decomposing these into direct and behavioral effects. The sign of direct and behavioral effects depends on the form of reference-dependent payoffs; which of these effects matter for welfare depends on whether reference dependence reflects a bias or a normative preference. We derive sufficient statistics formulas quantifying the social welfare effects of changes in reference points and prices in terms of estimable reduced-form parameters and normative judgments. We illustrate these findings with an empirical application to reference dependence exhibited in German workers' retirement decisions. We find positive social welfare effects of increasing the Normal Retirement Age, but ambiguous effects of financial incentives to postpone retirement.
Keywords: reference dependence; welfare economics; retirement decisions
JEL Codes: D60; D90; H55
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| changes in the reference point (F32) | direct welfare effects (I38) |
| reference dependence is judged as a normative preference (D81) | direct welfare effects arise from changing the reference point (D69) |
| reference dependence viewed as a bias (D91) | no direct effect occurs (F69) |
| reference dependence viewed as a bias (D91) | internality arises leading to a first-order behavioral welfare effect (D62) |
| increasing the normal retirement age (J26) | positive social welfare effects (D69) |
| financial incentives to postpone retirement (J26) | ambiguous effects (D91) |
| changes in reference points (C62) | influence individual welfare outcomes (I14) |
| welfare effects of price changes (D69) | contingent upon normative judgments and reference-dependent payoffs (D81) |