A Canonical Model of Choice with Initial Endowments

Abstract

We use the revealed preference method to derive a model of individual decision making when the endowment of an agent provides a reference point that may influence her choices. This model generalizes the classical rational choice model, which views choice as a consequence of “utility maximization”. Instead, our model sees choice as arising from “psychologically constrained utility maximization”, where the constraints are induced by one's initial endowment. In particular, this model produces status quo bias as a natural consequence (but not necessarily the endowment effect). A range of economic applications identify the predictive and explanatory strength of the model. In particular, we demonstrate that the status quo bias phenomenon reduces the size of the substitution effect in problems of consumption choice.