Consumer Demand Under Price Uncertainty: Empirical Evidence from the Market for Cigarettes

57 Pages Posted: 18 May 2006 Last revised: 20 Sep 2010

See all articles by Mark Coppejans

Mark Coppejans

BlackRock, Inc; Barclays Global Investors

Donna B. Gilleskie

University of North Carolina (UNC) at Chapel Hill - Department of Economics

Holger Sieg

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Koleman S. Strumpf

Wake Forest University, Department of Economics; University of Kansas - School of Business

Date Written: April 2006

Abstract

The goal of this paper is to analyze consumer demand in markets with large price uncertainty. We develop a demand model for goods that are subject to habit formation. We show that consumption plans of forward looking individuals depend not only on preferences and current period prices, but also on individual beliefs about the evolution of future prices. Moreover, a mean preserving spread in the price distribution and, hence, an increase in price uncertainty reduces consumption along the optimal path. With smoking as our application, we test the predictions of our model. We use a unique data set of prices for cigarettes collected by the Bureau of Labor Statistics to characterize price uncertainty and price expectations of individuals. We have also obtained access to the restricted use version of the National Education Longitudinal Study, which provides detailed information on smoking behavior of teenagers in the U.S. Our estimation results suggest that teenagers who live in metropolitan areas with a large amount of cigarette price volatility have, on average, significantly lower levels of cigarette consumption. Moreover, these individuals are less likely to start consuming cigarettes. Our results also provide evidence that young individuals are forward looking. Myopic individuals would not respond to an increase in uncertainty about future prices by reducing consumption.

Suggested Citation

Coppejans, Mark T. and Gilleskie, Donna B. and Sieg, Holger and Strumpf, Koleman S., Consumer Demand Under Price Uncertainty: Empirical Evidence from the Market for Cigarettes (April 2006). NBER Working Paper No. w12156. Available at SSRN: https://ssrn.com/abstract=896464

Mark T. Coppejans

BlackRock, Inc ( email )

San Francisco, CA
United States

Barclays Global Investors ( email )

45 Fremont Street
San Francisco, CA 94105
United States

Donna B. Gilleskie (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Chapel Hill, NC 27599
United States

Holger Sieg

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Koleman S. Strumpf

Wake Forest University, Department of Economics ( email )

2601 Wake Forest Road
Winston-Salem, NC 27109
United States

University of Kansas - School of Business ( email )

1300 Sunnyside Avenue
1300 Sunnyside Ave.
Lawrence, KS 66045
United States
785-864-7485 (Phone)
785-864-5328 (Fax)

HOME PAGE: http://people.ku.edu/~cigar/

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