Reference Health and Investment Decisions

Abstract

Reference points influence economic decisions. This paper considers how health reference points and their adaptation to decreasing health influence medical spending, consumption, and investment in a dynamic model. A static reference point implies an aspiration to offset health losses already at a high initial level. In contrast, the case of reference adaptation entails much lower lifetime healthcare expenditure that concentrates late in life. A projection bias, i.e., the agent’s failure to anticipate the reference adaptation, induces behavior that initially resembles the static reference case. With decaying health, choices approach, but remain distinct, to those derived for adaptive reference health.

Keywords: Investment, medical spending, optimal control, behavioral economics, reference adaptation

JEL Classification: G11, G40, I10