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Rational Habits and Uncertain Prices: Simulating Gasoline Consumption Behavior

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  • K. Rebecca Scott

Abstract

When consumers are forward-looking with respect to their demand for a habit-forming good, traditional measures of price elasticity are misleading.� In particular, such measures will underestimate sensitivity to long-run shifts - and therefore underestimate the potential effect of policy instruments that act through price.� Correcting elasticities for the behavior of the price process requires a model with forward-looking consumers, a habit-forming good, and uncertain relative prices.� With appropriate restrictions on the type of price uncertainty, this paper shows that it is possible to solve for the optimal consumption path under any price process.� Simulations then sketch out how habits and the price process shape demand.� Gasoline demand motivates the model and illustrates its implications.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 596.

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Date of creation: 01 Mar 2012
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Handle: RePEc:oxf:wpaper:596

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Keywords: Gasoline demand; Rational habits; Price elasticity;

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