Reference-Dependent Preferences and Labor Supply: The Case of New York City Taxi Drivers

Increased attention has been paid in recent years to deviations from the standard neoclassical model of consumer behavior. A substantial segment of this work focuses on reference-dependent preferences where there is a change in the shape of the utility function at some base (reference) level of income or consumption. These models have strong predictions for how responses to changes in prices are affected by the actual level of consumption or income relative to the reference level. A difficulty in bringing this class of models to the data is that the reference level of income or consumption is seldom observed, and we have only weak information on what determines the reference point. There are important reasons to understand how these considerations affect estimation of labor supply elasticities. Evaluation of much government policy regarding tax and transfer programs depends on having reliable estimates of the sensitivity of labor supply to wage rates and income levels. To the extent that individuals’ levels of labor supply are the result of optimization with reference-dependent preferences, the usual estimates of wage and income elasticities are likely to be misleading. In this study, I develop an empirical model of daily labor supply that incorporates referencedependent preferences but does not require that the reference level of income be observed or defined in advance. I apply this model to data on the daily labor supply of New York City taxi drivers by allowing taxi drivers to have a reference level of daily income. The estimates suggest that, while there may be a reference level of income on a given day such that there is a discrete increase in the probability of stopping when that income level is reached, the reference level varies substantially day to day for a particular driver. Additionally, most shifts end before the reference income level is reached. Essentially, the data show more smoothness in the relationship between income and the continuation and stopping probabilities than seems consistent with an important role for reference-dependent preferences.