Towards a more general approach to testing the time additivity hypothesis

Abstract

A new procedure is proposed for re-examining the assumption of additivity of preferences over time which, although untenable, is usually maintained in intertemporal analyses of consumption and labour supply. The method is an extension of a famous work by Browning (1991). However, it is more general in permitting the estimation of Frisch demands, which are explicit in an unobservable variable (price of utility), but may lack a closed form representation in terms of observable variables such as prices and total outlay. It also makes an extensive use of duality theory to solve the endogeneity problem encountered in Browning ' s study. Applying this method with an appropriate estimator to the Australian disaggregate data, we find that the intertemporal additivity hypothesis is decisively rejected, which is consistent with Browning ' s conclusion. Results also indicate that the effects of lagged and future prices in determining current consumption decisions are insubstantial.JEL Classification System-Numbers: D11, D12, D91.

Commodity Rates of Interest and Intertemporal Substitution in Commodity Demand and Consumption

“…Moreover, we have the following decomposition of commodity demand relating the Marshallian and Frisch price elasticities (Theil, 1975;McLaughlin, 1995): 20 Empirical analysis of the Frisch demand and consumption functions often approximates E t [ln(λ t+1 /λ t )] in (4) by the real interest rate (r t ) (see Browning, Deaton, and Irish, 1985;Altonji and Ham, 1990). Browning (1991) shows that the unobservability of λ t can be circumvented by using the Frisch expenditure function (15) in which λ t is solved in terms of expenditure and commodity prices (see also Wong, 2003).…”

“…Frisch demand functions have also been gaining increasing popularity in dynamic macro analysis (see Turnovsky, 1995, Chapters 9-12). Moreover, in a dual context, Frisch demand functions can be derived from the consumer profit function; see Browning, Deaton, and Irish (1985), Browning (1991), Cornes (1992), Cooper and McLaren (1993) and Wong (2003). 6 This statement is correct if the consumer has point expectations, but is not correct if the consumer's expectations are in the form of probability distributions.…”

“…Browning (1991) andWong (2003) find that the intertemporal separability hypothesis is decisively rejected.25 For an alternative approach, seeBrowning (1991) andWong (2003).…”