Durable goods and consumer behavior with liquidity constraints

• Published date: 01 January 2024
• Author: H. Youn Kim,José Alberto Molina,K. K. Gary Wong
• Date: 01 January 2024
• DOI: http://doi.org/10.1111/sjoe.12546

Scand. J. of Economics 126(1), 155–193, 2024

DOI: 10.1111/sjoe.12546

Durable goods and consumer behavior

with liquidity constraints

H. Youn Kim

Western Kentucky University, Bowling Green, KY 42101, USA

youn.kim@wku.edu

Jos´

e Alberto Molina†

University of Zaragoza, 50005 Zaragoza, Spain

jamolina@unizar.es

K. K. Gary Wong

University of Macau, Taipa, Macau SAR, China

garywong@um.edu.mo

Abstract

This paper presents an integrated model of intratemporal demand and intertemporal consumption,

with allowance for durable goods and liquidity constraints. Demand equations for non-durable

and durable goods with the user cost of durable goods are jointly estimated with a consumption

Euler equation incorporating liquidity constraints for Norwegian consumers from 1978 to 2018.

Results show that demand analyses ignoring durable goods lead to a significant bias in the

elasticities of non-durable goods. Norwegian consumers are found to be impatient, with low risk

aversion. There is weak evidence for liquidity constraints in consumption. No strong evidence

exists for intertemporal substitution in consumption, but a considerable effect of uncertainty is

found in durable consumption.

Keywords: Euler equation; indirect utility function; intertemporal substitution; risk aversion;

user cost of durable goods

JEL classification:D12; D15; E21

1. Introduction

There is an increasingly large body of empirical work analyzing consumer

behavior from both micro and macro perspectives. Traditionally, the two

strands of the study of consumer behavior are conducted in isolation of

each other. Demand analysis, which represents the micro study of consumer

behavior, is typically concerned with optimal allocation of consumption

expenditure across goods within periods, and thus demand functions are

†Also affiliated with the Institute on Employment, Digital Society and Sustainability (IEDIS).

c

2023 The Authors. The Scandinavian Journal of Economics published by John Wiley & Sons Ltd on behalf of F¨

oreningen

f¨

or utgivande av the SJE.

This is an open access article under the terms of the Creative Commons Attribution-NonCommercial-NoDerivs License,

which permits use and distribution in any medium, provided the original work is properly cited, the use is non-commercial

and no modifications or adaptations are made.

156 Durable goods and consumer behavior with liquidity constraints

estimated conditional on total expenditure, which is usually treated as

exogenously given and is left unexplained. However, to the extent that

the consumer chooses expenditure to optimally allocate wealth across

periods, which is a focus in consumption/saving analysis typifying the macro

study of consumer behavior, consumption expenditure is not exogenously

given, but is endogenously determined in the consumer’s optimization

problem. This implies that the consumer’s intratemporal (within period)

and intertemporal (across period) allocation decisions, though seemingly

disjointed, are inextricably linked together and cannot be separated.

In particular, time preference, the interest rate, and uncertainty, which

determine the intertemporal consumption decision, indirectly influence the

intratemporal allocation decision as represented by consumer demands.

However, commodity prices as determinants of the intratemporal allocation

decision also have an effect on the intertemporal consumption decision. This

leads us to infer that the traditional approach to consumer behavior, based on

separation of research on consumer demand and consumption, likely leads to

biased results. Hence, a proper understanding of consumer behavior entails

an integration of consumer demand and consumption studies in a unifying

framework.

The purpose of this study is to present an integrated model of consumer

demand and consumption, with allowance for durable goods and liquidity

constraints, which is then estimated to provide new evidence from Norwegian

consumers. The model is based on the idea of intertemporal two-stage

budgeting that jointly accounts for the consumer’s intratemporal and

intertemporal choices (Kim and McLaren, 2023), with relative prices of

non-durable goods and the user cost of durable goods. The integrated

model of consumer behavior embeds micro analysis of consumer demand

within an intertemporal optimization problem by endogenizing consumption

expenditure, and provides the micro-foundational underpinnings to macro

analysis of consumption by allowing for relative prices of non-durable

goods. Our contribution lies in a coherent treatment of consumer behavior,

analyzed separately in traditional demand and consumption studies, with more

realism, by incorporating non-durable, as well as durable goods, with liquidity

constraints. This will allow us to examine relevant issues in consumer demand

and consumption, such as demand elasticities, risk aversion, intertemporal

substitution, and precautionary saving, in a unifying framework with more

reliable results than in the traditional approach to consumer behavior.

To achieve our goal of a joint analysis of consumer demand and

consumption, we characterize consumer preferences by using an indirect

utility function, specified as a function of total consumption on non-durable

and durable goods, as well as of prices of these goods, with durable goods

expressed in a stock form and their price represented by the user cost. We

then derive the demand functions for non-durable and durable goods. We also

c

2023 The Authors. The Scandinavian Journal of Economics published by John Wiley & Sons Ltd on behalf of F¨

oreningen

f¨

or utgivande av the SJE.

H. Y. Kim, J. A. Molina, and K. K. G. Wong 157

generalize the traditional measure of risk aversion based on power, or CRRA

utility, by utilizing the indirect utility function. Next, from the intertemporal

optimization with the indirect utility function, we obtain a Euler equation

governing intertemporal consumption behavior, with allowance for liquidity

constraints. By taking a log-normal approximation of the Euler equation, we

derive a log-linearized consumption growth equation that depends on the time

preference rate, the interest rate, growth rates of non-durables prices, and user

costs, conditional variance capturing uncertainty with precautionary savings,

and liquidity constraints.

We conduct an empirical analysis of the integrated model of consumer

behavior, using annual Norwegian data for 1978–2018 on eight disaggregate

non-durable goods and an aggregate durable good. We employ a flexible

specification of the indirect utility function that places minimal restrictions

on consumer preferences with a rank 3 demand system. We jointly

estimate the system of nine budget share equations, together with the

Euler equation for consumption. Then, we present new evidence on demand

and intertemporal consumption relative to previous studies on Norwegian

consumer behavior.

We find that a joint analysis of intratemporal and intertemporal choices is

essential for a proper understanding of consumer behavior. Ignoring durable

goods leads to a significant bias in the elasticities of non-durable goods.

Durable goods are largely found to be necessities, and are price-inelastic,

like most non-durable goods. Norwegian consumers are, in general, impatient

with low risk aversion. There is weak evidence for liquidity constraints, which

does not have an important influence on consumption. No strong evidence

exists for intertemporal substitution in the consumption of non-durable and

durable goods, although there is a considerable effect of uncertainty. This

suggests that increasing uncertainty causes consumers to reduce or defer

current non-durable and durable spending, accompanied by an increase in

precautionary savings, especially in times of economic weakness, as observed

during the recent pandemic.

In contrast to our approach to analyzing consumer behavior that jointly

accounts for the consumer’s intratemporal and intertemporal allocation

decisions, traditional studies fail to consider the interaction between the

two allocation decisions with allowance for durable goods and liquidity

constraints. In demand studies, durable goods are either ignored, tacitly

assuming that non-durable goods are separable from durable goods (Deaton

and Muellbauer, 1980b; Banks et al., 1997), or treated like non-durable goods,

without recognizing the inherent differences between the two classes of

goods (see Clements et al., 2020). Both approaches are not satisfactory.

While most studies of consumption focus on non-durable consumption

(e.g., Hall, 1978; Hansen and Singleton, 1983; Ludvigson and Paxson, 2001),

there are studies analyzing non-durable consumption by incorporating durable

c

2023 The Authors. The Scandinavian Journal of Economics published by John Wiley & Sons Ltd on behalf of F¨

oreningen

f¨

or utgivande av the SJE.