Modelling Addiction in Life-Cycle Models: Revisiting the Treatment of Latent Stocks and Other Unobservables

Erik Biorn

No 26/2009, Memorandum from Oslo University, Department of Economics

Abstract: Dynamic modeling of demand for goods whose cumulated stocks enter an intertemporal utility function as latent variables, is discussed. The issues include: how represent addiction, how handle unobserved expectations and changing plans, how deal with `dynamic inconsistency'? Arguments are put forth to give all optimizing conditions attention, not only those in which all variables are observable. If the latter, fairly common, `limited information-reduced dimension' strategy is pursued, problems are shown to arise in attempting to identify coe±cients of the preference structure and to test for addictive stocks. Examples, based on quadratic utility functions, illustrate the main points and challenge the validity of testing the `rational addiction' hypothesis, by using linear, single- equation autoregressive models, as suggested by Becker, Grossman, and Murphy (1994) and adopted in several following studies.

Keywords: Life-cycle model. Addiction. Identi¯cation. Latent stocks; Perfect foresight; Ra- tional expectations; Dynamic inconsistency (search for similar items in EconPapers)
JEL-codes: C32 C51 D91 I12 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2009-12-15
New Economics Papers: this item is included in nep-ecm and nep-neu
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