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Price Uncertainty, Tax Policy, and Addiction: Evidence and Implications

  • Mark Coppejans
  • Holger Sieg
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    Consumption of addictive goods is subject to habit formation. Forward-looking individuals must, therefore, be concerned about future prices when making current consumption decisions. We study prices for tobacco products based on a unique data set provided by the Bureau of Labor Statistics. Our empirical findings suggest that prices have been highly volatile during the past decade. Price uncertainty has a potentially large impact on the economic well-being of young individuals with relatively low levels of disposable income. We develop a model to study consumption of addictive substances under price uncertainty. Our results indicate that optimal decision rules of low income individuals can crucially depend on subjective beliefs about future prices and the length of the planning horizon. These results imply that tax policies are most effective in reducing teenage cigarette consumption if they credibly alter individuals' beliefs about future prices.

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    File URL: http://www.nber.org/papers/w9073.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9073.

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    Date of creation: Jul 2002
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    Handle: RePEc:nbr:nberwo:9073
    Note: HE PE
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    2. Becker, Gary S & Grossman, Michael & Murphy, Kevin M, 1994. "An Empirical Analysis of Cigarette Addiction," American Economic Review, American Economic Association, vol. 84(3), pages 396-418, June.
    3. Chaloupka, Frank, 1991. "Rational Addictive Behavior and Cigarette Smoking," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 722-42, August.
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    5. Gary S. Becker & Kevin M. Murphy, 1986. "A Theory of Rational Addiction," University of Chicago - George G. Stigler Center for Study of Economy and State 41, Chicago - Center for Study of Economy and State.
    6. Athanasios Orphanides & David Zervos, 1992. "Rational addiction with learning and regret," Finance and Economics Discussion Series 216, Board of Governors of the Federal Reserve System (U.S.).
    7. Gary S.Grossman Becker & Michael Murphy & Kevin M., 1991. "Rational Addiction and the Effect of Price on Consumption," University of Chicago - George G. Stigler Center for Study of Economy and State 68, Chicago - Center for Study of Economy and State.
    8. Christopher Harris & David Laibson, 1999. "Dynamic Choices of Hyperbolic Consumers," Harvard Institute of Economic Research Working Papers 1886, Harvard - Institute of Economic Research.
    9. Jonathan Gruber & Botond Köszegi, 2001. "Is Addiction "Rational"? Theory And Evidence," The Quarterly Journal of Economics, MIT Press, vol. 116(4), pages 1261-1303, November.
    10. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
    11. Chaloupka, Frank J. & Warner, Kenneth E., 2000. "The economics of smoking," Handbook of Health Economics, in: A. J. Culyer & J. P. Newhouse (ed.), Handbook of Health Economics, edition 1, volume 1, chapter 29, pages 1539-1627 Elsevier.
    12. Hansen, Bruce E, 1992. "The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages S61-82, Suppl. De.
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