IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/14304.html
   My bibliography  Save this paper

Reconsidering the Economics of Demand Analysis with Kinked Budget Constraints

Author

Listed:
  • Aaron Strong
  • V. Kerry Smith

Abstract

This paper has two objectives. First, we identify a problem with the ability of the discrete-continuous choice (DCC) framework and conditional demand functions to fully describe consumer preferences in the presence of kinked budget constraints. Second, we propose and illustrate an alternative, preference based, method for estimating consumer responses to price changes under these conditions. Our preference based approach yields price elasticities on the order of 0.4 and a "utilities expenditure" elasticity of near unity. This research highlights the possibility that households may be more sensitive to price schedules than previously thought. It is recognizes commitments to commodities such as pools or outdoor landscaping influence how water consumption responds to price changes as part of the long run adjustments.

Suggested Citation

  • Aaron Strong & V. Kerry Smith, 2008. "Reconsidering the Economics of Demand Analysis with Kinked Budget Constraints," NBER Working Papers 14304, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:14304
    Note: EEE
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w14304.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. David S. Bullock & Nicholas Minot, 2006. "On Measuring the Value of a Nonmarket Good Using Market Data," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 88(4), pages 961-973.
    2. Joshua D. Angrist & Alan B. Krueger, 2001. "Instrumental Variables and the Search for Identification: From Supply and Demand to Natural Experiments," Journal of Economic Perspectives, American Economic Association, vol. 15(4), pages 69-85, Fall.
    3. von Haefen R.H. & Phaneuf D.J. & Parsons G.R., 2004. "Estimation and Welfare Analysis With Large Demand Systems," Journal of Business & Economic Statistics, American Statistical Association, vol. 22, pages 194-205, April.
    4. von Haefen, Roger H., 2003. "Incorporating observed choice into the construction of welfare measures from random utility models," Journal of Environmental Economics and Management, Elsevier, vol. 45(2), pages 145-165, March.
    5. Epstein, Larry G, 1981. "Generalized Duality and Integrability," Econometrica, Econometric Society, vol. 49(3), pages 655-678, May.
    6. Palmquist, Raymond B., 2006. "Property Value Models," Handbook of Environmental Economics, in: K. G. Mäler & J. R. Vincent (ed.), Handbook of Environmental Economics, edition 1, volume 2, chapter 16, pages 763-819, Elsevier.
    7. Smith, V. Kerry, 1974. "Intertemporal production externalities, technical change, and public expenditure analysis," Journal of Environmental Economics and Management, Elsevier, vol. 1(2), pages 121-131, August.
    8. Jeffrey T. LaFrance & W. Michael Hanemann, 1989. "The Dual Structure of Incomplete Demand Systems," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 71(2), pages 262-274.
    9. Patrick Bayer & Fernando Ferreira & Robert McMillan, 2007. "A Unified Framework for Measuring Preferences for Schools and Neighborhoods," Journal of Political Economy, University of Chicago Press, vol. 115(4), pages 588-638, August.
    10. Ellen Hanak & Ada Chen, 2007. "Wet Growth: Effects Of Water Policies On Land Use In The American West," Journal of Regional Science, Wiley Blackwell, vol. 47(1), pages 85-108, February.
    11. Vartia, Yrjo O, 1983. "Efficient Methods of Measuring Welfare Change and Compensated Income in Terms of Ordinary Demand Functions," Econometrica, Econometric Society, vol. 51(1), pages 79-98, January.
    12. Zabalza, Antoni, 1983. "The CES Utility Function, Non-Linear Budget Constraints and Labour Supply: Results on Female Participation and Hours," Economic Journal, Royal Economic Society, vol. 93(37), pages 312-330, June.
    13. Julie A. Hewitt & W. Michael Hanemann, 1995. "A Discrete/Continuous Choice Approach to Residential Water Demand under Block Rate Pricing," Land Economics, University of Wisconsin Press, vol. 71(2), pages 173-192.
    14. Brown, James N & Rosen, Harvey S, 1982. "On the Estimation of Structural Hedonic Price Models," Econometrica, Econometric Society, vol. 50(3), pages 765-768, May.
    15. Blanciforti, Laura & Green, Richard, 1983. "An Almost Ideal Demand System Incorporating Habits: An Analysis of Expenditures on Food and Aggregate Commodity Groups," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 511-515, August.
    16. Peter C. Reiss & Matthew W. White, 2006. "Evaluating Welfare with Nonlinear Prices," NBER Working Papers 12370, National Bureau of Economic Research, Inc.
    17. von Haefen, Roger H., 2002. "A Complete Characterization Of The Linear, Log-Linear, And Semi-Log Incomplete Demand System Models," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 27(2), pages 1-39, December.
    18. Olmstead, Sheila M. & Michael Hanemann, W. & Stavins, Robert N., 2007. "Water demand under alternative price structures," Journal of Environmental Economics and Management, Elsevier, vol. 54(2), pages 181-198, September.
    19. Hanemann, W Michael, 1984. "Discrete-Continuous Models of Consumer Demand," Econometrica, Econometric Society, vol. 52(3), pages 541-561, May.
    20. Sudip Chattopadhyay, 1999. "Estimating the Demand for Air Quality: New Evidence Based on the Chicago Housing Market," Land Economics, University of Wisconsin Press, vol. 75(1), pages 22-38.
    21. Bockstael, Nancy E & McConnell, Kenneth E, 1983. "Welfare Measurement in the Household Production Framework," American Economic Review, American Economic Association, vol. 73(4), pages 806-814, September.
    22. Arrufat, Jose Luis & Zabalza, Antonio, 1986. "Female Labor Supply with Taxation, Random Preferences, and Optimization Errors," Econometrica, Econometric Society, vol. 54(1), pages 47-63, January.
    23. K. G. Mäler & J. R. Vincent (ed.), 2005. "Handbook of Environmental Economics," Handbook of Environmental Economics, Elsevier, edition 1, volume 3, number 3.
    24. Raj Chetty & Adam Szeidl, 2007. "Consumption Commitments and Risk Preferences," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 122(2), pages 831-877.
    25. Hausman, Jerry A., 1979. "The econometrics of labor supply on convex budget sets," Economics Letters, Elsevier, vol. 3(2), pages 171-174.
    26. Moffitt, Robert, 1986. "The Econometrics of Piecewise-Linear Budget Constraints: A Survey and Exposition of the Maximum Likelihood Method," Journal of Business & Economic Statistics, American Statistical Association, vol. 4(3), pages 317-328, July.
    27. Mansur, Erin T. & Olmstead, Sheila M., 2012. "The value of scarce water: Measuring the inefficiency of municipal regulations," Journal of Urban Economics, Elsevier, vol. 71(3), pages 332-346.
    28. repec:fth:prinin:455 is not listed on IDEAS
    29. Mendelsohn, Robert, 1985. "Identifying Structural Equations with Single Market Data," The Review of Economics and Statistics, MIT Press, vol. 67(3), pages 525-529, August.
    30. Jerry A. Hausman, 1980. "The Effect of Wages, Taxes, and Fixed Costs on Women's Labor Force Participation," NBER Chapters, in: Econometric Studies in Public Finance, pages 161-194, National Bureau of Economic Research, Inc.
    31. Burtless, Gary & Hausman, Jerry A, 1978. "The Effect of Taxation on Labor Supply: Evaluating the Gary Negative Income Tax Experiments," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1103-1130, December.
    32. Bockstael, Nancy E. & McConnell, Kenneth E., 1981. "Theory and estimation of the household production function for wildlife recreation," Journal of Environmental Economics and Management, Elsevier, vol. 8(3), pages 199-214, September.
    33. Edlefsen, Lee E, 1981. "The Comparative Statics of Hedonic Price Functions and Other Nonlinear Constraints," Econometrica, Econometric Society, vol. 49(6), pages 1501-1520, November.
    34. Smith, V. Kerry & Pattanayak, Subhrendu K. & Van Houtven, George L., 2003. "VSL reconsidered: what do labor supply estimates reveal about risk preferences?," Economics Letters, Elsevier, vol. 80(2), pages 147-153, August.
    35. Joshua Angrist & Alan Krueger, 2001. "Instrumental Variables and the Search for Identification: From Supply and Demand to Natural Experiments," Working Papers 834, Princeton University, Department of Economics, Industrial Relations Section..
    36. Ellen M. Pint, 1999. "Household Responses to Increased Water Rates during the California Drought," Land Economics, University of Wisconsin Press, vol. 75(2), pages 246-266.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. H. Allen Klaiber & V. Kerry Smith & Michael Kaminsky & Aaron Strong, 2014. "Measuring Price Elasticities for Residential Water Demand with Limited Information," Land Economics, University of Wisconsin Press, vol. 90(1), pages 100-113.
    2. Havranek, Tomas & Irsova, Zuzana & Vlach, Tomas, 2016. "Publication Bias in Measuring the Income Elasticity of Water Demand," MPRA Paper 75247, University Library of Munich, Germany.
    3. Baerenklau, Kenneth A., 2015. "Theoretically consistent welfare estimation under block pricing: the case of water demand," 2015 AAEA & WAEA Joint Annual Meeting, July 26-28, San Francisco, California 205723, Agricultural and Applied Economics Association.
    4. Henrique Monteiro, 2010. "Residential Water Demand in Portugal: checking for efficiency-based justifications for increasing block tariffs," Working Papers Series 1 ercwp0110, ISCTE-IUL, Business Research Unit (BRU-IUL).
    5. Tomas Havranek & Zuzana Irsova & Tomas Vlach, 2018. "Measuring the Income Elasticity of Water Demand: The Importance of Publication and Endogeneity Biases," Land Economics, University of Wisconsin Press, vol. 94(2), pages 259-283.
    6. Kenneth A. Baerenklau & María Pérez-Urdiales, 2019. "Can Allocation-Based Water Rates Promote Conservation and Increase Welfare? A California Case Study," Water Economics and Policy (WEP), World Scientific Publishing Co. Pte. Ltd., vol. 5(02), pages 1-26, April.
    7. Brandli Stitzel & Cynthia L. Rogers, 2022. "Residential Water Demand Under Increasing Block Rate Structure: Conservation Conundrum?," Water Resources Management: An International Journal, Published for the European Water Resources Association (EWRA), Springer;European Water Resources Association (EWRA), vol. 36(1), pages 203-218, January.
    8. Baerenklau, Kenneth A. & Schwabe, Kurt & Dinar, Ariel, 2014. "Do Increasing Block Rate Water Budgets Reduce Residential Water Demand? A Case Study in Southern California," 2014 Annual Meeting, July 27-29, 2014, Minneapolis, Minnesota 170019, Agricultural and Applied Economics Association.
    9. Wichman, Casey J., 2014. "Perceived price in residential water demand: Evidence from a natural experiment," Journal of Economic Behavior & Organization, Elsevier, vol. 107(PA), pages 308-323.
    10. Kenneth A. Baerenklau & Kurt A. Schwabe & Ariel Dinar, 2014. "The Residential Water Demand Effect of Increasing Block Rate Water Budgets," Land Economics, University of Wisconsin Press, vol. 90(4), pages 683-699.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Olmstead, Sheila M. & Michael Hanemann, W. & Stavins, Robert N., 2007. "Water demand under alternative price structures," Journal of Environmental Economics and Management, Elsevier, vol. 54(2), pages 181-198, September.
    2. Baerenklau, Kenneth A., 2015. "Theoretically consistent welfare estimation under block pricing: the case of water demand," 2015 AAEA & WAEA Joint Annual Meeting, July 26-28, San Francisco, California 205723, Agricultural and Applied Economics Association.
    3. Klaiber, H. Allen & Smith, V. Kerry & Kaminsky, Michael & Strong, Aaron, 2010. "Estimating the Price Elasticity of Demand for Water with Quasi Experimental Methods," 2010 Annual Meeting, July 25-27, 2010, Denver, Colorado 61039, Agricultural and Applied Economics Association.
    4. von Haefen, Roger H., 2007. "Empirical strategies for incorporating weak complementarity into consumer demand models," Journal of Environmental Economics and Management, Elsevier, vol. 54(1), pages 15-31, July.
    5. Mansur, Erin T. & Olmstead, Sheila M., 2012. "The value of scarce water: Measuring the inefficiency of municipal regulations," Journal of Urban Economics, Elsevier, vol. 71(3), pages 332-346.
    6. Cristina Lopez-Mayan, 2014. "Microeconometric Analysis of Residential Water Demand," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 59(1), pages 137-166, September.
    7. Kenneth A. Baerenklau & María Pérez-Urdiales, 2019. "Can Allocation-Based Water Rates Promote Conservation and Increase Welfare? A California Case Study," Water Economics and Policy (WEP), World Scientific Publishing Co. Pte. Ltd., vol. 5(02), pages 1-26, April.
    8. H. Allen Klaiber & V. Kerry Smith & Michael Kaminsky & Aaron Strong, 2014. "Measuring Price Elasticities for Residential Water Demand with Limited Information," Land Economics, University of Wisconsin Press, vol. 90(1), pages 100-113.
    9. Wang, Xiangrui & Lee, Jukwan & Yan, Jia & Thompson, Gary D., 2017. "Modeling Rational But Inattentive Consumer’s Residential Water Demand," 2017 Annual Meeting, July 30-August 1, Chicago, Illinois 258555, Agricultural and Applied Economics Association.
    10. Phaneuf, Daniel J. & Smith, V. Kerry, 2006. "Recreation Demand Models," Handbook of Environmental Economics, in: K. G. Mäler & J. R. Vincent (ed.), Handbook of Environmental Economics, edition 1, volume 2, chapter 15, pages 671-761, Elsevier.
    11. Rolf Aaberge & Ugo Colombino, 2014. "Labour Supply Models," Contributions to Economic Analysis, in: Handbook of Microsimulation Modelling, volume 127, pages 167-221, Emerald Group Publishing Limited.
    12. Zhang, Zibin & Cai, Wenxin & Feng, Xiangzhao, 2017. "How do urban households in China respond to increasing block pricing in electricity? Evidence from a fuzzy regression discontinuity approach," Energy Policy, Elsevier, vol. 105(C), pages 161-172.
    13. Nicolai V. Kuminoff & V. Kerry Smith & Christopher Timmins, 2010. "The New Economics of Equilibrium Sorting and its Transformational Role for Policy Evaluation," NBER Working Papers 16349, National Bureau of Economic Research, Inc.
    14. Baerenklau, Kenneth A. & Schwabe, Kurt & Dinar, Ariel, 2014. "Do Increasing Block Rate Water Budgets Reduce Residential Water Demand? A Case Study in Southern California," 2014 Annual Meeting, July 27-29, 2014, Minneapolis, Minnesota 170019, Agricultural and Applied Economics Association.
    15. Nicolai V. Kuminoff & V. Kerry Smith & Christopher Timmins, 2013. "The New Economics of Equilibrium Sorting and Policy Evaluation Using Housing Markets," Journal of Economic Literature, American Economic Association, vol. 51(4), pages 1007-1062, December.
    16. Wang, Xiangrui & Lee, Jukwan & Yan, Jia & Thompson, Gary D., 2018. "Testing the behavior of rationally inattentive consumers in a residential water market," Journal of Environmental Economics and Management, Elsevier, vol. 92(C), pages 344-359.
    17. Daniel A. Brent, 2016. "Estimating Water Demand Elasticity at the Intensive and Extensive Margin," Departmental Working Papers 2016-06, Department of Economics, Louisiana State University.
    18. V. Smith & Mary Evans & H. Banzhaf & Christine Poulos, 2010. "Can Weak Substitution be Rehabilitated?," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 45(2), pages 203-221, February.
    19. Bessho, Shun-ichiro & Hayashi, Masayoshi, 2011. "Labor supply response and preferences specification: Estimates for prime-age males in Japan," Journal of Asian Economics, Elsevier, vol. 22(5), pages 398-411, October.
    20. Koji Miyawaki & Yasuhiro Omori & Akira Hibiki, 2018. "A discrete/continuous choice model on a nonconvex budget set," Econometric Reviews, Taylor & Francis Journals, vol. 37(2), pages 89-113, February.

    More about this item

    JEL classification:

    • H42 - Public Economics - - Publicly Provided Goods - - - Publicly Provided Private Goods
    • Q21 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Demand and Supply; Prices

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:14304. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/nberrus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.