Rational Addiction with Optimal Inventories: Theory and Evidence from Cigarette Purchases in Japan

Junmin Wan ()

No 04-01-Rev, Discussion Papers in Economics and Business from Osaka University, Graduate School of Economics

Abstract: A rational addiction (RA) model with optimal inventories is developed and empirically tested. Consumers hoard addictive goods when they anticipate a future price increase. The optimal inventory period increases with the size of the price hike but decreases with inventory costs. The absolute value of the price elasticity of demand is smaller in the case of a price increase than in the case of a price decrease. Evidence from daily cigarette purchases in Japan is consistent with this asymmetric price effect. If inventories are ignored, monthly cigarette purchases reject the RA hypothesis inasmuch as inventories are an omitted variable correlated with price; but this hypothesis finds support if inventories are controlled for.

Keywords: Enforcement; rational addiction, tax increase, hoarding, optimal stopping, asymmetric price effect, omitted variable (search for similar items in EconPapers)
JEL-codes: C12 D11 D12 H31 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2004-01, Revised 2006-02
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Working Paper: Rational Addiction with Optimal Inventories: Theory and Evidence from Cigarette Purchases in Japan (2005)
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