Demand and price uncertainty: Rational habits in international gasoline demand

Given a rational agent, demand for a habit-forming good is sensitive to uncertainty in future prices. In particular, price uncertainty reduces both the level and the price responsiveness of demand. These two effects, which may bear heavily on the efficacy of policies to discourage consumption of harmful addictive goods, can be tested by augmenting a simple demand model with a measure of price uncertainty. Modeling gasoline as a habit-forming good offers a succinct way to capture the investment and behavioral decisions that determine gasoline usage. An uncertainty-augmented model is therefore applied to gasoline demand across a panel of 29 countries, 1990-2011. Price uncertainty as proxied by a measure of forecast error does in fact depress the level and the price responsiveness of demand. This suggests that consumers care about the time-series process of gasoline prices, and that traditional demand models will systematically mis-predict the consumer reaction to any policy that tinkers with this process. (C) 2014 Elsevier Ltd. All rights reserved.