Rational Addiction - The Becker and Murphy (1988) Model

The Becker and Murphy (1988) Model

The original theory models addictions as the implementation of a forward-looking consumption plan made under full certainty and perfect information, where the individual is entirely committed toward maximizing utility. Addiction is defined in a non-physiological sense as a causal effect of past consumption on current consumption, so that addictiveness is specific to individuals. The addict knows exactly how the good will affect him, and the reason he consumes more and more ("gets hooked") is that this is the pattern of consumption that maximizes his discounted utility. He knows that consuming the addictive good will change his preferences, altering both his future baseline level of utility and the marginal utility of consuming the addictive good in the future. For example, a modeled smoker realizes that smoking one more cigarette today will increase his desire to smoke tomorrow and decrease his future health. Rational choice amounts to comparing the benefit of smoking that cigarette to the total discounted costs of smoking that cigarette, including both the monetary cost of the cigarette, the health damages of that cigarette, and the costs of increased future smoking resulting from greater addiction. As a result, if cigarette taxes are credibly announced to double in one year's time, cigarette smokers will cut their smoking today, because the anticipated future costs of addiction to tobacco have gone up.

A sizeable econometric literature has developed on rational addiction, often reporting evidence in favor of rational addiction. For example, Gruber and Koszegi (2001) show that the model's prediction that announced future tax increases should decrease current smoking is consistent with the evidence. Auld and Grootendorst (2004) show, however, that the empirical version of the rational addiction model tends to produce spurious evidence of addictiveness when aggregate data are used.