Intertemporal Effects of Consumption and Their Implications for Demand Elasticity Estimates

50 Pages Posted: 13 Sep 2006

See all articles by Wesley R. Hartmann

Wesley R. Hartmann

Stanford Graduate School of Business

Date Written: January 2006

Abstract

Consumption of a good typically diminishes the marginal utility of consuming more, but for how long? This paper adapts a model of consumption capital to allow consumption to have a lasting effect that diminishes the marginal utility of future consumption. Estimates of the model find that it takes the 25th, median and 75th percentile of consumers 19, 32 and 43 days for their marginal utilities to return to pre-consumption levels, and they are forward-looking with respect to these effects. This generates intertemporal substitution of consumption that leads to an overestimate of the own-price elasticity of demand of ten percent when it is estimated using temporary price changes. In addition to these implications consumption effects share with those of durable and storable goods, consumption effects also raise concerns for capacity constrained industries because the timing of consumption affects capacity utilization. In the empirical application in this paper, price variation in one time period generates substantial changes in capacity utilization in that period, but minimal changes in other periods because the intertemporal substitution is spread over many time periods.

Keywords: consumption, discrete choice, dynamic programming, random coefficients

JEL Classification: L0, D12, C61

Suggested Citation

Hartmann, Wesley R., Intertemporal Effects of Consumption and Their Implications for Demand Elasticity Estimates (January 2006). Available at SSRN: https://ssrn.com/abstract=929489 or http://dx.doi.org/10.2139/ssrn.929489

Wesley R. Hartmann (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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