Aggregate Demand Model Research Articles

Sectoral Money Demand and the Great Disinflation in the US

Estimates of the welfare costs of inflation based on Bailey (1956) are typically computed using aggregate money demand models. Yet, the behavior of money demand may vary across sectors. Thus, the impact on welfare of inflation regime shifts may differ between households and firms. We specifically investigate the sectoral welfare implications of the shift from the Great Inflation to the present regime of low and stable inflation. For this purpose, we estimate different functional specifications of money demand for US households and non-financial firms using flow-of-fund data covering four decades. We find that the benefits were significant for both sectors. JEL Classification: E31, E41

From Keynes to Solow to optimal growth: An encompassing model of monetary and fiscal policy

A dynamic, out-of-equilibrium model of aggregate demand and supply is specified. The existence of, and convergence to, a macroeconomic equilibrium is derived, and the existence of a supporting revealed social utility function is established. Empirical estimates for three recent historical ‘eras’ suggest the model's explanatory power is impressive. Implications for possible policy repercussions include striking shifts in effect.

A Model to Deal with Aggregate Supply and Demand Imbalances: The Case of Greece

The effort to achieve the convergence criteria and the participation in the euro zone has coincided with a period of high, domestic-demand led growth in the Greek economy, continuing fiscal imbalances, a booming current account deficit, and relatively high unemployment. The economy needs rebalancing both on the demand and the supply sides. A model of aggregate supply and demand is constructed to show certain aspects of this rebalancing.

Traveled distance, stock and fuel efficiency of private vehicles in Canada: price elasticities and rebound effect

This paper presents estimates of the rebound effect and other elasticities for the Canadian light-duty vehicle fleet using panel data at the provincial level from 1990 to 2004. We estimate a simultaneous three-equation model of aggregate demand for vehicle kilometers traveled, vehicle stock and fuel efficiency. Price and income elasticities obtained are broadly consistent with those reported in the literature. Among other results, an increase in the fuel price of 10% would reduce driving by ~2% in the long term and by 1% the average fuel consumption rate. Estimates of the short- and long-term rebound effects are ~8 and 20%, respectively. We also find that an increase in the gross domestic product per capita of 10% would cause an increase in driving distance of 2–3% and an increase of up to 4% in vehicle stock per adult. In terms of policy implications, our results suggest that: (1) the effectiveness of new fuel efficiency standards will be somewhat mitigated by the rebound effect and (2) fuel price increases have limited impacts on gasoline demand.

Demand estimation under limited product availability

Consumer purchases are determined, in part, by the assortment of products available at retailers. Despite this, commonly employed aggregate demand models fail to control for the fraction of stores that carry a given item. We detail the conditions under which aggregate demand is consistently estimated when heterogeneity in product assortment is ignored. The required assumptions are quite strict and likely violated in many empirical applications. Even when they hold, however, a problem of inference arises. One cannot tell whether a lack of interaction between two products is due to limited substitution in those stores where both are available or because many stores do not carry both products. This is a significant shortcoming since in many situations it is important to distinguish between these two possibilities.

Consumption and labor supply

Abstract We present a new econometric model of aggregate demand and labor supply for the United States. We also analyze the allocation full wealth among time periods for households distinguished by a variety of demographic characteristics. The model is estimated using micro-level data from the Consumer Expenditure Surveys supplemented with price information obtained from the Consumer Price Index. An important feature of our approach is that aggregate demands and labor supply can be represented in closed form while accounting for the substantial heterogeneity in behavior that is found in household-level data. As a result, we are able to explain the patterns of aggregate demand and labor supply in the data despite using a parametrically parsimonious specification.

On Indexed Bonds and Aggregate Demand Elasticity

Bonds indexed to the price level or inflation have become popular and more common in the industrialized world. This paper examines the impact of indexed bonds on the price level elasticity of aggregate demand. With a model of aggregate demand based on the standard IS-LM framework and expanded to differentiate between bonds which are indexed to the price level and bonds which are not so indexed, we find that the existence of indexed bonds decreases the elasticity of aggregate demand with respect to the general price level.

A comment on W. Wei and M. Hansen’s benefit estimation in “An aggregate demand model for air passenger traffic in the hub-and-spoke network”

This comment analyzes the demand model and method used by W. Wei and M. Hansen for computing the benefits of an airport capacity extension. The log-linear specification and coefficients of the demand function imply that the airport extension’s positive effect on demand decreases with the volume of traffic and associated congestion. If this unlikely result is accepted, the surplus method used by Wei and Hansen underestimates the users’ investment benefit. The note argues that the marginal willingness to pay for a capacity extension should rather increase with congestion. If this is the case, the method used by Wei and Hansen could actually overestimates the benefit. A better specification would rather allow for a function concave to the origin in order to account for capacity constraints, and also set a maximum finite price. Above all, a fair evaluation of the users’ benefit should be based on a function which explicitly includes a variable, or function of variables, that permits an estimation of the users’ cost of congestion.

Biases in demand analysis due to variation in retail distribution

Aggregate demand models typically assume that consumers choose between all available products. Since consumers may be unwilling to search across every store in a given market for a particular item, this assumption is problematic when product assortments vary across stores. Using supermarket scanner data for five product categories we demonstrate that approximately one third of products have limited retail distribution, which account for one fourth of dollar sales. Monte Carlo analysis demonstrates that the level of limited product availability observed in the data can significantly bias the results of aggregate demand models that incorrectly assume all consumers in a given market face the same choice set.

On Some Effects of International Fragmentation of Production on Comparative Advantages, Trade Flows and the Income of Countries

In traditional trade models, whether based on technological differences or on relative factor endowments, merchandise composition and directions of trade are derived from closed‐economy conditions. But nowadays one of the basic assumptions of traditional trade models, i.e. that production processes are integrated within just one country, is being increasingly violated as previously integrated productive activities are segmented and spread over an international network of production sites: as a result, an increasingly large share of trade flows is made up of intermediate and unfinished goods being transferred from one country to another in order to be processed. In this paper we submit that such new configuration of production processes has important effects on at least three dimensions of economic research. First, we show that international disintegration of production processes leads to a lessening of the power of comparative advantages when it comes to explaining both merchandise composition and directions of trade, while it is the concept of absolute advantage to become increasingly relevant; second, we show that empirical measures of revealed comparative advantages are inherently misleading if they do not account for differences in the stage‐of‐processing of traded goods; third, we estimate a simple model of aggregate demand accounting for international trade in intermediates: results of estimation lend support to our prior that participation of a country in the process of international fragmentation of production plays a specific and significant role in determining its year‐over‐year change in GDP.

Interaction between price, quality and country of origin when estimating automobile demand: the case of Turkey

We estimate the demand for new automobiles in Turkey immediately following its entry to Custom Union with the European Union in 1996. We use quarterly data on price, quantity, quality, country of origin and product characteristics of the new automobile sales market and macroeconomic variables to estimate market demand during 1996–1999 using dynamic Generalized Least Squares Estimation method. In addition to including quality, we also include country of origin, to serve as another proxy for quality and to capture differences in cost-increasing and demand-reducing trade restrictions imposed on cars from certain countries as well as taste differences. Our results indicate that country of origin as well as quality matter for automobile demand in Turkey. Consistent with other aggregate automobile demand models for other countries, the demand for new automobiles is found to be price inelastic in the short run.

Biases in Demand Analysis Due to Variation in Retail Distribution

Aggregate demand models typically assume that consumers choose between all available products. Since consumers may be unwilling to search across every store in a given market for a particular item, this assumption is problematic when product assortments vary across stores. Using supermarket scanner data for five product categories we demonstrate that approximately one third of products have limited retail distribution, which account for one fourth of dollar sales. Monte Carlo analysis demonstrates that the level of limited product availability observed in the data can significantly bias the results of aggregate demand models that incorrectly assume all consumers in a given market face the same choice set.

The nature of the ADAS model based on the ISLM model

The aggregate demand and supply model (ADAS) is interpreted as a synthesis of the Keynesian and neoclassical models. It uses the ISLM model, without explaining its nature, to derive aggregate demand (AD). It is combined with an aggregate supply (AS) curve to explain price- inflation and output dynamics. This paper argues that neither the AD nor AS curve is conceptually the same as its microeconomic counterpart and ADAS is not a synthesis. In fact ADASimplies that discretionary policy is necessary and that price changes do not perform their traditional negative feedback function.

An aggregate demand model for air passenger traffic in the hub-and-spoke network

In this paper, we build an aggregate demand model for air passenger traffic in a hub-and-spoke network. This model considers the roles of airline service variables such as service frequency, aircraft size, ticket price, flight distance, and number of spokes in the network. It also takes into account the influence of local passengers and social-economic and demographic conditions in the spoke and hub metropolitan areas. The hub airport capacity, which has a significant impact on service quality in the hub airport and in the whole hub-and-spoke network, is also taken into consideration. Our demand model reveals that airlines can attract more connecting passengers in a hub-and-spoke network by increasing service frequency than by increasing aircraft size in the same percentage. Our research confirms the importance of local service to connecting passengers, and finds that, interestingly, airlines’ services in the first flight leg are more important to attract passengers than those in the second flight segment. Based on data in this study, we also find that a 1% reduction of ticket price will bring about 0.9% more connecting passengers, and a 1% increase of airport acceptance rate can bring about 0.35% more connecting passengers in the network, with all else equal. These findings are helpful for airlines to understand the effects of changing their services, and also useful for us to quantify the benefits of hub airport expansion projects. At the end of this paper, we give an example as an application to demonstrate how the developed demand model could be used to valuate passengers’ direct benefit from airport capacity expansion.

Effect of price information on residential water demand

Microeconomic theory predicts that people decrease consumption when price increases, the magnitude of the effect depending on price elasticity. The law of demand, however, implicitly assumes that consumers know prices, an assumption that is not always satisfied in markets with ex post billing. When prices are not transparent, elasticity estimates are potentially lower than their full information potential. Evidence of low price elasticity abounds in residential water demand studies, limiting the effectiveness and desirability of using price signals as a conservation tool. It is hypothesized that resident's sluggish response to price is partly due to the absence of price information on water bills. Differences in the informational content of bills are documented for the first time on the basis of sample bills collected from 383 utilities across the USA. A standard aggregate water demand model is augmented with qualitative variables describing differences in billing information, allowing such variables to affect the intensity with which consumers respond to price signals. No evidence is found that non-price information items affect price elasticity but there is a statistically significant effect in the case of price-related information; in our sample, price elasticity increases by 30% or more when price information is given on the bill.

Using water bills to reinforce price signals: evidence from the USA

In areas subject to drought and/or high population growth, measures to encourage conservation have become an important part of water management and planning. Residential consumers' low sensitivity to prices reduces the effectiveness and desirability of using price signals as a conservation tool. We hypothesize that consumers' sluggish response to prices is partly due to the fact that price information is not conveniently available to them. If the hypothesis is true, including clear price information on water bills should reinforce consumers' sensitivity to price and therefore increase the power of price-based policies in demand management strategies. A standard aggregate water demand model is augmented with qualitative variables describing the informational content of bills and estimated using a cross section of US utilities. Our results indicate that a utility that spells out unit prices on the water bill can achieve the same level of conservation as others with a thirty to forty percent lower rate increase. We find no evidence that non-price information such as history of use or conservation messages has a significant effect on demand.

Pitfalls of using unit values as a price measure or price index

In many well known studies, unit values are often used in place of observed prices when constructing price indexes or modeling demand systems. This study shows that one cannot get consistent estimates by replacing prices with their unit values. When computing price indexes, the use of unit values or unit value indexes will misspecify substitution effects and mismeasure the true price. The use of unit values as a price regressor in an aggregate demand model will misspecify the model even though the functional form of the demand model is correct. I then present empirical investigations using cereal sales data to evaluate a well known paper that estimated the welfare gain of a new cereal brand. I show that the use of unit values in this study biases the estimate of the welfare gain of the new brand. JEL Codes: C43, C51.

Financial constraints and the balance sheet channel: a re-interpretation

Aggregate demand models extending IS/LM fixed price framework yield an enhancement mechanism of the traditional monetary transmission mechanism, the credit channel, which, according to the credit view, works through the ‘balance sheet channel’ and the ‘bank lending channel’. In this paper the augmented IS/LM model is modified assuming that investments may be financed by both internal and external sources of funds. The inclusion of internal funds in the augmented IS/LM fixed price model suggests a different interpretation of the ‘balance sheet channel’ as an enhancement mechanism amplifying monetary policy effects through the quantity rather than the cost of borrowing. Thus, changes in borrowers’ net worth over the cycle can amplify and propagate output fluctuations directly rather than indirectly as in the traditional interpretation of the balance sheet channel. The empirical analysis of the monetary transmission mechanism for Italy in the last decade accords with the interpretation of the balance sheet channel proposed in this paper.

Accounting for Primary and Secondary Demand Effects with Aggregate Data

Discrete choice models of aggregate demand, such as the random coefficients logit, can handle large differentiated products categories parsimoniously while still providing flexible substitution patterns. However, the discrete choice assumption may not be appropriate for many categories in which we expect consumers may purchase more than one unit of the selected item. We derive the aggregate demand system corresponding to a discrete/continuous household-level model of demand. We also propose a method-of-simulated-moments procedure that provides consistent estimates of the structural parameters when only aggregate data are available. The procedure also enables the researcher to control both for the potential endogeneity of marketing variables as well as potential heterogeneity in consumer tastes. Using our aggregate estimates, we can measure the decomposition of price elasticities into incidence, brand choice, and purchase quantity components. We also propose several empirical tests to assess the validity of the discrete/continuous demand system versus that of the logit model. In several simulation experiments, we demonstrate the robustness of this model across datasets in which quantity choices may or may not be important. Our empirical calibration to store-level data in the refrigerated orange juice category indicates a considerable improvement in fit of the observed aggregate sales using the discrete/continuous model.

Sources of inflation and output movements in Poland and Hungary: Policy implications for accession to the economic and monetary union

The paper examines the sources of fluctuations in inflation and output in Poland and Hungary. Using a rational expectations, dynamic open economy aggregate supply–aggregate demand model and considering several disturbances, it is found that balance of payments shocks are important in price level movements in Hungary while nominal shocks are dominant in affecting prices in Poland. Monetary shocks affect output in the short run in Hungary while supply shocks dominate output movements in Poland. A major component of inflation is demand driven, “core” inflation. Finally, the paper discusses policy implications of findings regarding membership in the Economic and Monetary Union.