Outline

Loss Aversion, Education, and Inter-Generational Income Mobility

1. Introduction

a. Fair playing field

b. Number of factors contributing to inequality

i) Education

ii) Innate ability

iii) Starting point

(1) Intergenerational mobility (or lack thereof)

c. How do parents contribute?

i) Financially

(1) Allows children to reduce losses in first (education) period

ii) Genetically

(1) IQ

(2) Other factors

iii) Setting reference level of consumption

(1) Level at which children will shoot when making education decisions

iv) Borrowing constraints

(1) Limits possible education for children from lower end of income distribution if related to parent income

(2) Increases loss in first (education) period for higher levels of education

d. Importance of loss aversion

i) Children from higher income families will take a loss in period one in order to reach reference consumption in period two

2. Model

a. Setup

i) Overlapping generations (3 periods)

ii) “Earnings ability” iid

iii) Education choice/wage determination

iv) Loss aversion (reference consumption)

v) Bequest motive (warm glow)

vi) Borrowing constraint

b. Loss Aversion

i) Weak vs. Strong

ii) Consumption/Savings patterns

c. Borrowing constraints

i) Weak (borrow up to cost of education)

ii) Strong (borrow up to some fraction of family income)

d. Bequest motive

3. Review of the data

a. Income distribution

i) By education level

b. Intergenerational correlations

i) Income

ii) Education

c. Educational attainment by family income

i) Mixed once controlling for parental education

d. Transition matrix for income quantiles

4. Simulations

a. Parameter values

b. Variables

c. Main results

i) Percent at each education level

ii) Distribution of income

iii) Correlation of inter-generational income

iv) Correlation of inter-generational education

v) Correlation of inter-generational consumption

vi) Correlation of inter-generational bequests

vii) Transition matrix for simulated income quantiles

d. Results without loss aversion, borrowing constraints, bequests

i) No habit formation

ii) Habit formation

iii) Add loss aversion

iv) Add borrowing constraints

v) Add bequests

vi) Show how much each adds individually and how they work together

5. Conclusion

a. Model shows three main ways that parent income can be transferred to child income

i) Loss aversion

ii) Borrowing constraints (when strong)

iii) Bequests

b. Work together to explain a significant portion of the inter-generational correlation of income

i) But not the only source

c. Potential policy implications

i) While these results may be individually utility maximizing, they are not socially optimal

(1) Would like people to maximize their lifetime resources (max GDP)

ii) Possible ways to do that:

(1) Make education financing available to all

(a) Include consumption allowance

(2) Inheritance tax