Dynamic modelling of consumption patterns using LA-AIDS: a comparative study of developed versus developing countries

Abstract

The traditional applied demand system estimation assumes that when consumer income and commodity prices change, the consumers instantaneously fully adjust to a new consumption equilibrium level and use a static demand system such as Static Linear Almost Ideal Demand System (Static LA-AIDS) for estimation. However, in real-life situations, such an assumption does not hold as consumers take time to settle to a new consumption equilibrium level. Hence, dynamic demand system estimations generate more nuanced insights into the short-run dynamics of consumer demand. This paper estimates two forms of dynamic versions of AIDS, Dynamic LA-AIDS and the error-corrected LA-AIDS, and compares the results with the Static LA-AIDS. The paper also models the consumption patterns of consumers in developed and developing countries and provides a comparative analysis of implied elasticities using recent data. The results show that the dynamic models support demand theory hypotheses—demand homogeneity and Slutsky symmetry—more than the static model. The estimated mean own-price elasticities reveal that the demand in the short-run and long-run is price inelastic across all countries. Long-run and short-run income elasticities demonstrated notable variation across various commodity groups and country groups. For example, the restaurant meal is a luxury in the short-run for all countries. In the long-run, it is a necessity in developed countries and a luxury in developing countries. Food and housing are necessities; durables, transport and recreation are luxuries in developed and developing countries in the long-run and short-run.