Demand and price volatility: rational habits in international gasoline demand

The combination of habits and a forward outlook suggests that consumers will be sensitive not just to prices but to price dynamics. In particular, rational habits models suggest 1. that price volatility and uncertainty will reduce demand for a habit-forming good and 2. that such volatility will dampen demand?s responsiveness to price. These two implications can be tested by augmenting a traditional partial-adjustment or error-correction model of demand. I apply this augmented model to data on gasoline consumption, as rational habits provide a succinct representation for the investment and behavioral decisions that determine gasoline usage. The trade-o¤s among 2SLS, system GMM, and pooled mean group (PMG) estimators are considered, and my preferred PMG estimator provides evidence for the two implications of rational habits in a panel of 29 countries for the years 1990-2009. The sensitivity of certain results to the choice of estimator o¤ers a cautionary illustration of the cost of assumptions such as coe¢ cient heterogeneity. Given the evidence uncovered in favor of rational gasoline habits, such habits may help to explain some of the cross-country variation in "total" price elasticity. These habits also imply that the e¤ect of price volatility must be taken into account when projecting the impacts of potential policies on gasoline consumption.