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Deep Habits

Author

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  • Morten O. Ravn
  • Stephanie Schmitt-Grohe

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 countercyclical markups, 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 procyclical and hence counterfactual markup movements. The paper also provides econometric estimates of the parameters pertaining to the deep habit model

Suggested Citation

  • Morten O. Ravn & Stephanie Schmitt-Grohe, 2004. "Deep Habits," 2004 Meeting Papers 208, Society for Economic Dynamics.
    • Handle: RePEc:red:sed004:208
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    References listed on IDEAS

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    More about this item

    Keywords

    Habit formation; customer market models; switching cost models; time varying mark-ups and business cycles;
    All these keywords.

    JEL classification:

    • D10 - Microeconomics - - Household Behavior - - - General
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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