Working Paper: CEPR ID: DP4269
Authors: Morten Ravn; Stephanie Schmitt-Grohé; Martín Uribe
Abstract: This Paper generalizes the standard habit formation model to an environment in which agents form habits over individual varieties of goods as opposed to over a composite consumption good. We refer to this preference specification as ?deep habit formation?. Under deep habits, the demand function faced by individual producers depends on past sales. This feature is typically assumed ad-hoc in customer market and brand switching cost models. A central result of the Paper is that deep habits give rise to counter cyclical mark-ups, which is in line with the empirical evidence. This result is important because ad-hoc formulations of customer-market and switching-cost models have been criticized for implying pro-cyclical and hence counterfactual mark-up movements. The Paper also provides econometric estimates of the parameters pertaining to the deep habit model.
Keywords: business cycles; customer market models; habit formation; switching cost models; time varying markups
JEL Codes: D10; D12; D42; E30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| deep habit formation (D91) | counter-cyclical markups (D43) |
| increase in output driven by preference shocks (D11) | decrease in markups (D43) |
| increase in output driven by government spending shocks (E19) | decrease in markups (D43) |
| increase in output driven by productivity shocks (O49) | decrease in markups (D43) |
| current consumption of a good (D12) | future demand for that good (R22) |