Too slow a change? Deep habits, consumption shifts and transitory tax

Inge van den Bijgaart

No 701, Working Papers in Economics from University of Gothenburg, Department of Economics

Abstract: This paper studies shifts in the consumption bundle when consumption is subject to habit formation, and consumers do not internalize this habit formation process. Habits are goodspecific, or ’deep’, and cause persistence in good-specific consumption. In addition, at the aggregate level, habits act as benchmark against which consumption is evaluated. I establish that a rapid transition is optimal if the persistence effect is relatively strong, and determine the path of taxes or subsidies that implements this transition, both when goods are produced competitively and when they are produced by monopolists. To explore the quantitative implications of the model I consider the introduction of a 10 percent charge on a subset of goods. I find that consumption adjusts inefficiently fast; implementing first-best adjustment requires a transitory discount of up to 60 percent of the cost increase.

Keywords: habit formation; projection bias; consumption shifts; optimal taxation (search for similar items in EconPapers)
JEL-codes: D11 D62 H21 H23 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2017-06
New Economics Papers: this item is included in nep-pbe
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Citations: View citations in EconPapers (2)

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