An Empirical Analysis of Biases in Cigarette Addiction

I embed rational choice along with two types of psychological biases into a model describing the consumption of an addictive good, and empirically investigate the extent to which these biases help explain observed smoking patterns. Rational agents correctly maximize their lifetime utility, whereas “presentbiased” agents have a taste for immediate gratification, and “projection-biased” agents underestimate how much their future tastes are affected by current behavior. Consumers may have any degree, including zero, of both biases. I use MSA-level variation in cigarette price shocks over a 26-year span to examine individual smoking responses to current and predicted future prices, and to price volatility. I find that while both young smokers and mature smokers respond to the current price (with a 1% price increase lowering the probability of smoking by between 1% and 2%), only mature smokers respond to the future price. This youthful myopia is consistent with either type of biased consumers but not with fully rational ones. The ratio of the future-price response to current-price response among mature response yields an estimate of the net discount rate. Decomposing prices into a permanent and a transitory component, I use mature smokers’ responses to separate out a short-run discount factor β ∈ [0.70, 0.83] and long-run discount factor δ ≈ 0.9. Because projection-biased agents do not fully appreciate the effect of current consumption on future behavior, they under-appreciate the “option value” of remaining unaddicted in an uncertain price environment. With an additional assumption on the utility function, I use the under-response to price volatility to estimate a degree of projection bias α ∈ [0.41, 0.49], meaning that people underestimate changes in tastes from smoking behavior by 40%. Overall, I find that a combination of present bias and projection bias explains significant deviations from rational cigarette consumption. Manipulating the price path to take full advantage of these biases could increase the cost in present value that a consumer pays for a lifetime smoking habit by a factor of 3. I find that relatively large taxes—between $8 and $11—would correct for the overconsumption caused by the two psychological biases. ∗University of California, Berkeley. Email: [email protected]. I thank my advisors Matthew Rabin, Stefano DellaVigna, and Botond Kőszegi for research guidance. I am also grateful to Ulrike Malmendier and Shachar Kariv for additional advice. I thank participants at the UC Berkeley Psychology and Economics Seminar, UC Berkeley Labor Lunch, UC Berkeley Psychology and Economics Lunch, and Michigan State University Theory Brownbag Seminar for their helpful comments.