Scandinavian Working Papers in Economics
Memorandum,
Oslo University, Department of Economics
No 26/2009: Modelling Addiction in Life-Cycle Models: Revisiting the Treatment of Latent Stocks and Other Unobservables
Erik Biørn ()
Additional contact information
Erik Biørn: Dept. of Economics, University of Oslo, Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
Abstract: 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.
Keywords: Life-cycle model. Addiction. Identi¯cation. Latent stocks; Perfect foresight; Ra- tional expectations; Dynamic inconsistency
26 pages, December 15, 2009
Full text files
Memo-26-2009.pdf
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