Are social preferences reference dependent? a study of reference dependent social preferences among students at the Norwegian School of Economics

Abstract

This thesis explores whether social preferences are reference dependent. More specifically it examines whether reference points, defined by expectations, regarding income inequality affect our willingness to redistribute income (pro-social behavior). The theoretical background for this thesis is two important insights from behavioral economics. The first insight comes from the theory of loss aversion – that people evaluate outcomes relative to a reference point shaped by their expectations. The second insight comes from the theory of social preferences – that people not only care about their own welfare (income), but also about other people’s welfare, and hence fairness and equality. Combined, these two insights suggest that people’s expectations regarding income inequality, as well as deviations from these expectations, influence how they evaluate their own utility – in addition to own income and deviations from own expected income. This thesis reports the results from an economic experiment designed to study the role of expectations in explaining redistributive behavior. The analysis is based on data from three separate lab-experiments conducted on the student body at The Norwegian School of Economics in the spring and early fall of 2012. Designed as a dictator game, the students were tested on how their willingness to redistribute income was affected by the implementation of different reference points through the use of treatments altering their expectations. The main finding of this thesis is that when people expect inequality they give away almost 30 percent less than when they expect equality, ceteris paribus. This is a huge effect, and demonstrates the importance of reference dependence in explaining pro-social behavior. The result may also be important in explaining why e.g. Americans redistribute a smaller share of their income than do taxpayers in Scandinavian countries, and to an extent why many welfare states differ to the degree which they do.