Consumption Commitments and Habit Formation

Consumption Commitments: Neoclassical Foundations for Habit Formation

This paper studies a model where consumption has two components, one that is costlessly adjustable and one that involves an adjustment cost. Agents have time-separable neoclassical preferences over the two components of consumption. We show that aggregating over a heterogeneous population of such agents implies dynamics identical to those of a representative consumer economy with habit formatio...

Consumption Commitments: A Foundation for Reference-Dependent Preferences and Habit Formation

We build a theory of reference-dependent preferences based on adjustment costs in consumption. The main contribution of the theory is that it endogenizes the evolution of the reference point. The reference point generated by our model exhibits several features exogenously assumed in existing theories: it (1) re‡ects recent expectations, (2) depends on past consumption levels, and (3) diminishes...

Consumption Models with Habit Formation

Consumption Models with Habit Formation

Solving Consumption Models with Habit Formation

The intuition for this equation is as follows. If λ, the parameter which controls how fast habits catch up with consumption, is equal to zero equation (6) reduces to the normal first order condition for the standard consumption optimization problem, which tells us that increasing consumption by today and reducing it by R in the next period must not change expected discounted utility. If λ is no...