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Revealed Bounded rationality:Testing present bias in a Rational Addiction Equation

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  • Pierpaolo Pierani
  • Silvia Tiezzi

Abstract

This paper deals with one of the main theoretical and empirical problems associated with the rational addiction model, namely that the demand equation derived from the rational addiction theory is not empirically distinguishable from models with forward-looking behavior, but with timeinconsistent preferences. The implication is that, even when forward-looking behavior can be convincingly supported, this equation cannot provide evidence in favor of time-consistent preferences against a model with dynamic inconsistency. In fact, we show that the possibility of testing for exponential versus non-exponential time discounting is nested within the rational addiction model. We propose a test of time consistency that uses only the information obtained from the general rational addiction demand equation and the price effects. A pseudo panel of Italian households is used to test for rational addiction in tobacco consumption. GMM estimators are used to deal with errors in variables and unobserved heterogeneity. The results conform to the theoretical predictions. We find evidence that tobacco consumers are forward-looking, but timeinconsistent. The values of the derived present bias and long run discount parameters are statistically significant and in line with the literature.

Suggested Citation

  • Pierpaolo Pierani & Silvia Tiezzi, 2012. "Revealed Bounded rationality:Testing present bias in a Rational Addiction Equation," Department of Economics University of Siena 666, Department of Economics, University of Siena.
    • Handle: RePEc:usi:wpaper:666
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    References listed on IDEAS

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    1. Hanming Fang & Dan Silverman, 2009. "Time-Inconsistency And Welfare Program Participation: Evidence From The Nlsy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 50(4), pages 1043-1077, November.
    2. Jonathan Gruber & Botond Köszegi, 2001. "Is Addiction "Rational"? Theory and Evidence," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 116(4), pages 1261-1303.
    3. M. Daniele Paserman, 2008. "Job Search and Hyperbolic Discounting: Structural Estimation and Policy Evaluation," Economic Journal, Royal Economic Society, vol. 118(531), pages 1418-1452, August.
    4. Ciccarelli, Carlo & Giamboni, Luigi & Waldmann, Robert, 2007. "Cigarette smoking, pregnancy, forward looking behavior and dynamic inconsistency," MPRA Paper 8878, University Library of Munich, Germany.
    5. Chaloupka, Frank, 1991. "Rational Addictive Behavior and Cigarette Smoking," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 722-742, August.
    6. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(2), pages 443-478.
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    More about this item

    Keywords

    rational addiction; time inconsistency; GMM;
    All these keywords.

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis

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