IS STATUS QUO BIAS CONSISTENT WITH DOWNWARD-SLOPING DEMAND?

Abstract

By now, there is a large experimental literature showing some kind of status quo bias. (1) If the subject is given a coffee mug (candy bar) and later given the possibility of trading it for a candy bar (coffee mug) of equal value, the subject is likely to stick with the original allocation (Knetsch, 1989). Here, we ask whether status quo bias can be made consistent with downward-sloping demand curves. This paper thus differs in intent from a large body of research that incorporates a different notion of status quo bias into a more general formulation of revealed preference (e.g., Masatlioglu and Ok, 2005; Sagi, 2006); such research demonstrates that there are different sets of primitives that lead to different axioms of revealed preference. In this paper, we do not care which set of primitives holds or whether such results can be incorporated into the neoclassical model of consumer behavior (as Munro and Sugden, 2003, have done). (2) Instead, we undertake a strict behavioralist approach: Individuals display status quo bias and downward-sloping demand curves. Whether such behavior can be derived from a consistent set of assumptions is irrelevant to our purpose. Indeed, we do not require the existence of a preference relation that rationalizes choices at all--all that is required is choice behavior. What we want to find out is the implications of such observed behavior; in particular, we want to determine whether status quo bias and downward-sloping demand curves are consistent with each other. The short answer is yes, but the consumer will display addictive behavior. (3) The remainder of the paper will be devoted to demonstrating this result. We will make the following set of assumptions: AI: There are two goods, x (candy) and y (wine), which are continuously divisible. A2: Prices and incomes are exogenously determined. That is, the person has a budget line and budget set. A3: The individual chooses a point on the budget line. A4: Strictly downward-sloping demand: if the person chooses [x.sub.t], [y.sub.t] for a given budget set, [b.sub.t], and then the person is faced with a different budget set, [b.sub.t+l], that goes through [x.sub.t], [y.sub.t] but where the relative price of x has gone down (up), then [X.sub.t+1] > [x.sub.t] and [y.sub.t+1] [y.sub.t]). (4) I. AN INTUITIVE EXAMPLE Before proceeding with the formal exposition, it is useful to consider the intuition behind the argument. To make the logic as accessible as possible, in the intuitive example, I will assume that individuals have indifference curves and that these indifference curves are homothetic. Before the subjects come to the experiment, they made choices based on their individual budget sets and preferences. The budget sets of these various individuals have the same slope (the market prices facing the individuals are the same), but the richer individuals have budget sets that are farther out. If individuals have status quo bias, then each individual's choice is based on his/her budget set and his/her unique set of indifference curves, which in turn are based on the reference point established by the individual's experiences and history. While we can use any time period for the analysis, let us suppose here that the time period of analysis is daily so that before and after the experiment, individuals decide each day how much candy and wine to choose. The experimenter divides the subjects into three groups. In the first group, the experimenter gives the subjects $10 and then each subject gets to choose either candy or wine (or some combination in between). Knetsch actually did this with candy and coffee cups and found that the subjects split evenly between the two choices. In the second group, the subjects are given $10 worth of candy and then later are allowed to trade in some or all of the candy for the equivalent value of wine. …