Modelling Addiction in Life-Cycle Models: Revisiting the Treatment of Latent Stocks and Other Unobservables

Erik Biørn

Memo 26/2009

Last ned memo

Dynamic modeling of demand for goods whose cumulated stocks enter an intertemporal utility function as latent variables, is discussed. The issues include: how represent addiction, how handle unobserved expectations and changing plans, how deal with `dynamic inconsistency'? Arguments are put forth to give all optimizing conditions attention, not only those in which all variables are observable. If the latter, fairly common, `limited information-reduced dimension' strategy is pursued, problems are shown to arise in attempting to identify coe±cients of the preference structure and to test for addictive stocks. Examples, based on quadratic utility functions, illustrate the main points and challenge the validity of testing the `rational addiction' hypothesis, by using linear, single-equation autoregressive models, as suggested by Becker, Grossman, and Murphy (1994) and adopted in several following studies.

Published June 20, 2014 12:59 PM - Last modified Jan. 24, 2019 11:43 AM