Valuing Utility Offsets to Regulations Affecting Addictive or Habitual Goods

08/03/2015

In analyzing the value consumers place on goods, economic analysis begins with the presumption that consumers reveal their preferences through their consumption behavior. This view is based on the notion that consumers are well informed and well situated to rationally balance the costs and benefits of purchasing a specific good or service. Under these assumptions regulations that reduce consumption of a good or service necessarily result in utility or welfare loss. There are several reasons to believe that consumption of addictive and habitual goods does not conform to the simple economics of consumer choice. First, consumers may not be fully informed about all costs, benefits and risks associated with such products. Information may be costly to acquire, complex and difficult to interpret. Or it may be deliberately distorted by companies aiming to promote their products. A second set of factors relates to the nature of the addictive and habitually-consumed products and ability to make rational choices. For example in the case of cigarettes young people may systematically misjudge or deny their likelihood of becoming addicted. Regular smokers may misjudge their ability to quit or underweight consequences of their consumption that occur in the distant future. Addiction and habituation will tend to make such errors in choice cumulate over time. In analyzing economic impacts of regulations aimed at addictive and habitual goods, a particular challenge concerns the issue of lost utility, sometimes referred to as lost consumer surplus. Regulations that induce smokers to quit or that dissuade people from eating foods that are high in calories, fats, sodium, or sugars have health benefits that can be quantified using standard methods of cost-benefit analysis. But should cost-benefit analysis also account for lost satisfactions of consumption people experience when they reduce their intake of such goods? If so on what basis could we value such “utility offsets” to health benefits of regulations? This paper develops a method for analyzing utility offsets to health benefits of regulations affecting addictive or habitual goods, with special emphasis on the case of smoking. The approach is analytically consistent with up-to-date representations of consumer behavior. It can also be implemented using existing data. The approach rests on identifying consumers most likely to be well-informed and to choose their consumption levels in ways that rationally weigh costs, benefits and risks. Then the values these consumers place on given levels of consumption can be used to estimate losses in utility that may result from regulations. Two different methods of identifying such consumers are used. The first takes smokers who do not meet criteria for nicotine dependence as the rational benchmark, on the grounds their consumption levels are less likely to be biased up by addiction. The second singles out smokers between the ages of 30 and 45 who have 4-year college degrees, on the grounds that they began smoking in an era when its health risks were well-known and that their education provides them with skills and knowledge relevant to accurately assessing benefits, costs and risks of smoking. Using this framework, we show that utility changes caused by regulations depend in part on the type of regulation, as regulations that primarily increase information work somewhat differently than regulations that raise the cost of smoking. Utility changes also differ across categories of consumers. Existing smokers induced to quit by a regulation experience three potential utility effects: short-term withdrawal costs, utility loss from reduced smoking satisfactions, and money savings. The first two items are subtractions from health benefits; the third adds to them. The analysis is somewhat different for reduced initiation. Potential smokers dissuaded from starting by the regulation realize money savings, but they do not incur withdrawal costs or utility losses, since they never initiate. Finally, existing smokers who continue to smoke or potential smokers who continue to initiate are not affected by regulations that increase information without changing their smoking behavior. But regulations that increase the cost of smoking do reduce their utility because higher costs imply reduced consumption in general. Our approach differs from two recent lines of work in this area. Unlike Ashley et al. (2015), we specifically analyze how regulations affect smoking initiation, showing that dissuading people from starting to smoke entails no utility offset. Unlike Chaloupka et al (2015), we recognize that existing smokers may experience utility losses even if they wish they had never started to smoke, because the preferences via which they evaluate utility changes reflect their consumption experience. We use this approach to work through examples of potential regulations, illustrating how estimated utility offsets can be calculated. The empirical analysis shows that the utility cost of smoking cessation is small relative to the health gains in people for whom withdrawal costs are the main utility loss of quitting, and even among people who have some ongoing loss, the utility offsets represent 20-25 percent of the health gains. While marginal smokers induced to quit by regulations can be expected to have low or no steady-state loss, even this higher estimate is far below prevailing estimates of the utility cost of smoking used by FDA and other analysts. The net result is that there are clear offsets to health benefits from reduced consumer utility associated with reduced smoking, but they are far smaller than some recent estimates in the literatur

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