Working Paper: NBER ID: w12156
Authors: Mark Coppejans; Donna Gilleskie; Holger Sieg; Koleman Strumpf
Abstract: The goal of this paper is to analyze consumer demand in markets with large price uncertainty. We develop a demand model for goods that are subject to habit formation. We show that consumption plans of forward looking individuals depend not only on preferences and current period prices, but also on individual beliefs about the evolution of future prices. Moreover, a mean preserving spread in the price distribution and, hence, an increase in price uncertainty reduces consumption along the optimal path. With smoking as our application, we test the predictions of our model. We use a unique data set of prices for cigarettes collected by the Bureau of Labor Statistics to characterize price uncertainty and price expectations of individuals. We have also obtained access to the restricted use version of the National Education Longitudinal Study, which provides detailed information on smoking behavior of teenagers in the U.S. Our estimation results suggest that teenagers who live in metropolitan areas with a large amount of cigarette price volatility have, on average, significantly lower levels of cigarette consumption. Moreover, these individuals are less likely to start consuming cigarettes. Our results also provide evidence that young individuals are forward looking. Myopic individuals would not respond to an increase in uncertainty about future prices by reducing consumption.
Keywords: Consumer Demand; Price Uncertainty; Cigarettes; Habit Formation
JEL Codes: C8; D8; I1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Price uncertainty (D89) | Cigarette consumption (D12) |
| Price volatility (G13) | Cigarette consumption among teenagers (I12) |
| Individual beliefs about future prices (D84) | Consumption plans (E21) |
| Forward-looking individuals (D84) | Consumption adjustment (E21) |
| Myopic individuals (D91) | Consumption sensitivity (D11) |
| Price levels (E30) | Smoking behavior (I12) |
| Price volatility (G13) | Smoking behavior (I12) |