The Effect of Unemployment on Consumption: An Experimental Analysis

Abstract

This paper reports on an experiment that investigates the apparently robust phenomenon of over-sensitivity of consumption to current income. Using a particularly simple formulation, we also investigate whether individuals correctly respond to their employment status. We find that subjects over-react. Our data enables us to investigate where this over-sensitivity originates; we conclude that economic agents differ in their ability to plan ahead and understand the dynamic process determining their employment status. However, agents seem able to respond appropriately to changes in the parameters governing their decision processes, in that the comparative static predictions of the theory are largely confirmed.* We would like to acknowledge financial support from the European Commission under the TMR grant 'Savings and Pensions'. We would like to thank participants at the TMR conference held in

An experimental test on dynamic consumption and lump-sum pensions

“…On the one hand, in Hey and Dardadoni (1988) and Carbone and Hey (2004) the rate of return per period is known and certain, for all money saved. On the other, in Ballinger et al (2004) and Brown et al (2006) the incentives to save money are embedded in their particular utility function, so saving is salient for subjects.…”

“…Our paper contributes to the experimental literature dealing with saving-consumption behavior (Camerer and Chua 2005;Carbone and Hey 2004;Ballinger et al 2004;Brown et al 2006). To our knowledge, this is the first experimental approach to examine a dynamic saving-consumption problem in a retirement framework.…”

“…They find that the actual behavior in the lab differs significantly from the optimal behavior, and that the comparative static implications of actual behavior agree with those of optimality theory. Carbone and Hey (2004) investigate the over-sensitivity of consumption to current income. They adopt a simple model in which income in any period can take just one of two values: employment and unemployment.…”

Comparing behavior under risk and under ambiguity in a lifecycle experiment

“…Other studies also report on people's difficulties in planning ahead, possibly due to the length of the planning horizon (see Carbone and Hey (2004); Hey and Panaccione (2011) or Hey andKnoll (2007, 2011)). In particular, Ballinger et al (2003) and Carbone and Hey (2004) include a discussion on the estimation of the planning horizon that participants seem to actually use to solve the inter-temporal consumption problem.…”

“…Several contributions in the literature, including experimental and empirical studies, have shown how people may have difficulties in optimally solving intertemporal consumption/saving problems 1 . Results have generally shown that participants fail to optimise lifetime utility, in some cases deviating significantly from the optimal consumption strategy (Hey and Dardanoni (1988); Ballinger et al (2003Ballinger et al ( , 2011Carbone and Hey (2004) as well as Brown et al (2009) Experiments on intertemporal consumption/saving problems have typically involved making decisions under risk on the distribution of income (over the life-cycle). In all these cases, participants have knowledge of the stochastic process determining income, no matter the specific procedure (or mechanism) employed.…”