Abstract
This paper addresses one of the main empirical problems associated with rational addiction theory, namely, that its derived demand equation is not empirically distinguishable from those of models with forward-looking behavior but with time-inconsistent preferences. Using an encompassing general specification of the rational addiction model we derive a microfounded test of time-consistency. The test allows us to distinguish between time-consistent versus time-inconsistent naïve agents. The results obtained from a panel of Russian individuals conform to the theoretical predictions of the rational addiction model and the proposed test for time-consistency does not reject the hypothesis that Russian cigarette consumers are time-consistent.
Highlights
Becker and Murphy (1988) explored the dynamic behavior of consumption of addictive goods, pointing out that many phenomena previously thought to be irrational are consistent with optimization according to stable preferences
Since we have an unbalanced panel, another practical difference is that the forward orthogonal deviations (FOD) transformation preserves the sample size in panels with gaps, where First differencing (FD) would reduce the number of observations12
Even when forward looking behavior is supported by data, the dynamic consumption equation derived from the rational addiction theory does not provide evidence in favor of time consistent preferences against a model with dynamic inconsistency (Gruber and Köszegi, 2001)
Summary
Becker and Murphy (1988) explored the dynamic behavior of consumption of addictive goods, pointing out that many phenomena previously thought to be irrational are consistent with optimization according to stable preferences In their model, individuals recognize both the current and future consequences of consuming addictive goods. This paper offers two distinct empirical contributions to the literature on addiction and time preferences It provides an estimate, using panel data at the individual level, of the general specification of the rational addiction demand equation that includes current, past and future prices. The rational addiction model and its derived general demand equation (Becker and Murphy, 1988 and Becker, Grossman and Murphy, 1990) are more general than the previous literature has argued They can discriminate between time consistent and time inconsistent consumers.
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