Welfare economics with status quo bias: a policy paralysis problem and cure

To analyze welfare economics with status quo bias, we identify each agent with the incomplete preference relation defined by the preference judgments that hold at all of the agent’s status quo points. Although the welfare theorems of general equilibrium theory continue to hold, the set of Pareto optima can be very large. For generic economies, almost every Pareto optimum sits amid an open set of Pareto optima, and the remaining measure-zero set of optima are on the boundary of this set. Thus, a small distortion would call for no policy response from a policymaker aiming for Pareto optimality. But these problems are specific to Pareto optimality as a welfare criterion. When a utilitarian planner faces agents with incomplete preferences, there will be a unique or at worst a low-dimensional set of optima. Moreover the utilitarian case for redistribution from low-marginal-utility agents to high-marginal-utility agents can be recast to cover agents with incomplete preferences. We also give several topological and measure-theoretic tests for whether or not an agent’s preferences are substantially incomplete, and then show that if agents display status quo bias they pass all but one of these tests. JEL Numbers: D11, D60, C60