Loss Aversion and Trade Policy

Loss Aversion and Trade Policy

This paper provides new survey evidence showing that loss aversion and reference dependence are important in shaping people's perception of trade policy. Under the assumption that agents' welfare functions exhibit these behavioral elemen...

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Bibliographic Details
Main Authors:	Freund, Caroline, Özden, Çağlar
Format:	Policy Research Working Paper
Language:	English en_US
Published:	World Bank, Washington, D.C. 2013
Subjects:	AGENTS AGRICULTURE CAMPAIGN CONTRIBUTIONS CENTRAL BANKS COMPETITIVENESS CONSTANT RETURNS TO SCALE CONSUMER SURPLUS CONSUMERS DEMAND ELASTICITY DEMAND FUNCTIONS ECONOMETRIC MODELS ECONOMICS ELASTICITY EMPIRICAL EVIDENCE EMPIRICAL STUDIES EMPLOYMENT ENDOWMENTS EQUILIBRIUM EXCESS DEMAND FIXED COSTS FREE TRADE IMPORTS INCOME INCOME LEVELS INFLATION INSURANCE INSURANCE MARKETS MARGINAL COST MARGINAL VALUE MARKET STRUCTURE NASH EQUILIBRIUM NET IMPORTS OFFSETTING POLICY INSTRUMENTS POLITICAL ECONOMY PRICE CHANGES PRICE DECLINES PRICE FLUCTUATIONS PRICE INCREASES PRODUCERS PRODUCTION TECHNOLOGY PROSPECT THEORY PROTECTIONISM QUOTAS RISK AVERSE RISK AVERSION RISK LOVING RISK SHARING SALES SPREAD SUPPLY FUNCTIONS TRADE BARRIERS TRADE POLICIES UTILITY FUNCTION UTILITY FUNCTIONS UTILITY THEORY VOTERS WELFARE FUNCTION WORLD MARKETS
Online Access:	http://documents.worldbank.org/curated/en/2004/09/5114379/loss-aversion-trade-policy http://hdl.handle.net/10986/14152

Description
Summary:	This paper provides new survey evidence showing that loss aversion and reference dependence are important in shaping people's perception of trade policy. Under the assumption that agents' welfare functions exhibit these behavioral elements, we analyze a model with a welfare-maximizing government and with the lobbying framework of Grossman and Helpman (1994). The policy implications of the augmented models differ in three important ways. One, there is a region of compensating protection, where a decline in the world price leads to an offsetting increase in protection, such that a constant domestic price is maintained. Two, protection following a single negative price shock will be persistent. Three, irrespective of the extent of lobbying, there will be a deviation from free trade that tends to favor loss-making industries. The augmented models are more consistent with the observed structure of protection, and in particular, explain why many trade policy instruments are explicitly designed to maintain prices at a given level.

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