Demand and Price Uncertainty: Rational Habits in International Gasoline Demand

The combination of habits and a forward outlook suggests that consumers will be sensitive not justto prices but to price dynamics. In particular, rational habits models suggest 1. that price volatilityand uncertainty will reduce demand for a habit-forming good and 2. that such volatility will dampendemand’s responsiveness to price. These two implications can be tested by augmenting a traditionalpartial-adjustment or error-correction model of demand. I apply this augmented model to data ongasoline consumption, as rational habits provide a succinct representation for the investment andbehavioral decisions that determine gasoline usage. The trade-o¤s among FE 2SLS, system GMM,and pooled mean group (PMG) estimators are considered, and my preferred estimators provideevidence of rational habits in a panel of 29 countries for the years 1990-2011. Such habits mayhelp to explain some of the cross-country and cross-time variation in ‘total’price elasticity. Thesehabits also imply that the e¤ect of price uncertainty must be taken into account when projecting theimpacts of potential policies on gasoline consumption.