Consumption Commitments: Neoclassical Foundations for Habit Formation

This paper studies a model where consumption has two components, one that is costlessly adjustable and one that involves an adjustment cost. Agents have time-separable neoclassical preferences over the two components of consumption. We show that aggregating over a heterogeneous population of such agents implies dynamics identical to those of a representative consumer economy with habit formation utility. In particular, aggregate consumption is a slow-moving average of past consumption levels, and risk aversion is ampli…ed because the marginal utility of wealth is determined by excess consumption over the prior commitment level. In certain cases, the representative consumer’s preferences and consumption dynamics coincide exactly with the exponential form of habit proposed by Constantinides (1990). Hence, consumption commitments provide simple, non-psychological micro-foundations for “habit.”