International Consumption Comparisons

International Consumption Comparisons

E. A. Selvanathan I S . World Scientific

i m**4

Infernofional ConsumpNon Comparisons OECD Versus LD

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International Consumption Comparisons (H>

E.

School of International Business and Asian Studies Faculty of Commerce and Management Griffith University, Australia

S. Selvanathan

School of Economics, Faculty of Commerce and Management, Griffith University, Australia

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World Scientific New Jersey • London • Singapore SL • Hong Kong

Published by World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore 596224 USA office: Suite 202,1060 Main Street, River Edge, NJ 07661 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

INTERNATIONAL CONSUMPTION COMPARISONS: OECD VERSUS LDC Copyright © 2003 by World Scientific Publishing Co. Pte. Ltd. All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the Publisher.

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ISBN 981-02-4005-8

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DEDICATION

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ABOUT T H E AUTHORS D t E A Selvanathan is an Associate Professor in the School of International Business and Asian Studies at Griffith University, Queensland, Australia. He was educated at the University of Jaffna (BA Hons), University of Bucurest (MSc) and Murdoch University, Western Australia (PhD). He has also taught for brief periods at the University of Jaffna, Murdoch University and the University of Western Australia. For the period 1994-1997, Dr Selvanathan was the Deputy Dean (Staffing) of the Faculty of International Business and Asian Studies, Griffith University. He has co-authored three research monographs and has widely published in international refereed journals such as Review of Economic Studies, Journal of Business and Economic Statistics, Journal of Econometrics, Review of Economics and Statistics and Marketing Science. In 1988, Dr Selvanathan was awarded the prestigious Inaugural 75th Anniversary Distinguished Teaching Award, The University of Western Australia. He has also co-authored two textbooks, including an Australian best-seller in Business Statistics entitled Australian Business Statistics. Dr Saroja Selvanathan is an Associate Professor in the School of Economics at Griffith University, Queensland, Australia. She was educated at the University of Jaffna (BSc Hons), Murdoch University (MPhil) and the University of Western Australia (PhD). Dr Selvanathan has also taught for brief periods at the University of Jaffna, Murdoch University and the University of Western Australia. For the period 1996-1997, Dr Selvanathan was the Deputy Dean (Research and Postgraduate Studies) of the Faculty of Commerce and Management, Griffith University. She has authored a research monograph and has co-authored another research monograph. Dr Selvanathan has also published widely in international refereed journals such as Review of Economics and Statistics, Empirical Economics, Economic Modelling and Economic Record. She has co-authored two textbooks, including an Australian best-seller in Business Statistics entitled Australian Business Statistics.

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PREFACE Understanding consumer reaction to price and income changes is of crucial importance for a host of microeconomic policy issues such as public-utility pricing, the measurement of distortions, optimal taxation and the treatment of externalities. The modern system-wide approach to applied demand analysis provides a unique approach to determine the factors that influence consumer decisions. This book presents a detailed analysis of the consumption patterns of consumers from 46 countries. The countries considered in the analysis are classified into two groups, namely, the Organisation for Economic Co-operation and Development (OECD) group — made up of a number of highly industrialized, rich countries, and the Less Developed (LD) group — made up of a number of relatively poor countries (totaling to about 9000 data points). Such a large and diverse body of data should provide convincing evidence, one way or the other, about a number of empirical regularities as well as the validity of the theory of the consumer. While the book reviews the theory of the consumer, it contributes more to the analysis of the consumption patterns of consumers around the Globe.

A Preview of the Book One of the primary objectives of applied demand analysis is to estimate demand systems to obtain income and price elasticities in order to use them to design microeconomic policies. With this objective, in Chapter 1 we present an

Vlll

overview of international consumption patterns and in Chapter 2 we present a review of the basics of demand theory. In Chapter 1, we present an overview of the OECD and LD countries and their consumer characteristics as well as a review of some of the previous international consumption studies. In Chapter 2, we present the basics of the economic theory of the consumer, discuss various consumer utility preference structures, review the differential approach to deriving demand systems and present a number of popular demand systems such as CBS, ADDS, translog and Rotterdam demand systems. In Chapter 3, we provide a preliminary data analysis of the consumption patterns in the OECD countries. We start this chapter by giving information about the data sources and the characteristics of the data set. We present a summary of the data in the form of Divisia indices. We investigate a number of empirical regularities of the consumers such as the Engel's Law, Law of demand and the famous Frisch's conjecture in these 23 OECD countries. The analysis of this chapter reveals that consumption tends to be more variable than prices and the consumers move away from those goods which have above average price increases — supports the law of demand. Furthermore, we find that the allocation of consumers' income on food decreases with their increasing income — supports Engel's law. Also the income elasticity of the marginal utility of income is not related to consumers' income - does not support Frisch's conjecture. We also derive initial estimates for income and price elasticities for the nine commodity groups in this chapter using the double-log demand systems. These initial estimates suggest that the OECD consumers consider food, housing, medical care and education as necessities; and clothing, durables, transport and recreation as luxuries. We also find that the demand for all goods in the OECD countries is price inelastic. We start Chapter 4 by giving details about the data source and the characteristics of the data for 23 LD countries. We use the same data analysis

IX

techniques introduced in Chapter 3 to present a preliminary analysis of the LDC data. The results show that the LD countries data supports the law of demand, Engel's law and does not support Frisch's famous conjecture. The elasticity estimates reveal that consumers in the LD countries consider food, housing and medical care as necessities; and clothing, durables, transport, education and recreation as luxuries. In general, demand for all goods in the LDC appear to be price inelastic. In Chapter 5, we compare the consumption patterns of the OECD and LD consumers based on the results of Chapters 3 and 4. We then combine the data sets for the two groups of countries to investigate the empirical regularities for the "World Consumers" as a whole. A comparison of the income allocation shows that OECD consumers allocate less proportion of their income on food compared to the LD consumers. OECD consumers allocate a higher proportion of their income on housing, medical care, transport and recreation than the LD consumers. Based on the pooled data, an average world consumer allocates about 33 percent of his/her income on food, 8 percent on clothing, 15 percent on housing, 8 percent on durables, 5 percent on medical care, 12 percent on transport, 7 percent on recreation, 1 percent on education and the remaining 12 percent on all other things. The results also show that both OECD and LDC data support Engel's law. Individual prices of consumer goods play a major role in consumer decisions as well as determine the rate of inflation, which impacts the economy as a whole. Thus studying the price movements is also important in understanding consumer behaviour. In Chapter 6, we study the prices and consumption of individual goods using the stochastic index numbers. According to this approach, the proportionate change in each individual price is taken to be equal to the underlying rate of inflation plus other components, which are random and nonrandom. The overall price index is then obtained by taking some

X

form of average of the individual price changes. An alternative to the stochastic approach is the functional approach whereby the form of the index is related to the underlying utility function. The attraction of the stochastic approach is that it provides standard errors for the price index. These standard errors increase with the degree of relative price variability. This agrees with the intuitive notion that when the individual prices move disproportionately, the overall rate of inflation is less well defined. We start this chapter by outlining the stochastic approach to index numbers and derive a number of theoretical results. We then apply these results to measure the price and quantity movements of the OECD and LD countries using the data presented in the previous chapters. Chapter 7 presents the final form of the estimating demand equations and tests demand theory hypotheses, demand homogeneity and Slutsky symmetry. The results show that homogeneity is universally acceptable by the OECD and LDC data and symmetry is acceptable to a lesser extent. In Chapter 2 of the book, we introduce a number of competing demand systems such as the Rotterdam, CBS, AIDS, etc. In Chapter 8, we estimate four of these demand systems using the OECD and LDC data and test the demand theory hypotheses, homogeneity and symmetry. For each country, a comparison of the performance of these four demand systems is presented using the information inaccuracies and a preferred demand system is then selected. In Chapter 9, we investigate a special form of utility structure — preference independence. The results show that preference independent utility structure is acceptable for most of the LD countries and by the majority of the OECD countries. In Chapter 9, we also give the final estimates of income and price elasticities of the nine commodity groups. The Appendix to this book, written by Wana Yang, Ken Clements and Dongling Chen, presents a shorter version of the User's Guide to the Demand Analysis Package, DAP2000. DAP2000 is an enhanced version of the Demand

XI

Analysis Package (DAP) written by S. Selvanathan, E.A. Selvanathan and Ken Clements in 1989. Features of DAP2000 include Preliminary data analysis, Hypotheses testing using both conventional asymptotic procedures and the Monte Carlo simulation approach, Estimation of demand systems and the Matrix approach to simulation (MAS), which is a recently-developed technique to evaluate demand systems. DAP2000 is extensively used in producing the results for Chapters 3, 4, 7 and 9 of this book.

E.A. Selvanathan Saroja Selvanathan January 2003

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xiii

TABLE OF CONTENTS PREFACE

vii

TABLE OF CONTENTS

xiii

LIST OF TABLES

xviii

LIST OF FIGURES

xxiv

TECHNICAL NOTES

xxvi

ACKNOWLEDGEMENTS

xxvii

CHAPTER 1: AN OVERVIEW OF INTERNATIONAL CONSUMPTION PATTERNS E^4. Selvanathan and S. Selvanathan

1

1.1 An Overview of the OECD and LD Countries 1.2 Consumption Theory 1.3 A Review of International Consumption Comparisons 1.4 A Pioneering International Consumption Study 1.5 Are Tastes Constant? References

2 6 14 17 22 26

CHAPTER 2: CONSUMER DEMAND MODELS JB^4. Selvanathan andS. Selvanathan

31

2.1 2.2

31 39

The Economic Theory of the Consumer The Structure of Preferences

xiv 2.3 Differential Approach to Deriving Demand Equations 2.4 Other Popular Demand Systems 2.5 More on the Differential Demand Equations 2.6 Aggregation and Consumer Demand References

43 52 59 63 65

CHAPTER 3: DATA ANALYSIS: OECD COUNTRIES S. Selvanathan andE^4. Selvanathan

71

3.1 DataSource 3.2 Summary Measures 3.3 Engel'sLaw 3.4 Preliminary Estimates of Income and Price Elasticities 3.5 Preliminary Estimates of the Income Flexibility 3.6 Testing the Frisch's Conjecture 3.7 The Validity of Preference Independence References

71 74 94 102 105 116 118 120

CHAPTER 4: DATA ANALYSIS: LESS DEVELOPED COUNTRIES E^4. Selvanathan and S. Selvanathan

125

4.1 DataSource 4.2 Summary Measures 4.3 Engle'sLaw 4.4 Preliminary Estimates of Income and Price Elasticities 4.5 Preliminary Estimates of the Income Flexibility 4.6 Testing the Frisch's Conjecture 4.7 The Validity of Preference Independence References

126 126 141 153 156 165 166 168

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CHAPTER 5: A COMPARISON OF CONSUMPTION PATTERNS IN THE OECD AND LD COUNTRIES E^4. Selvanathan and S. Selvanathan

169

5.1

Summary Measures

170

5.2

Empirical Regularities

175

5.3

Conclusion

182

CHAPTER 6: STOCHASTIC PRICE AND QUANTITY INDEX NUMBERS E~A. Selvanathan and S. Selvanathan

187

6.1 An Unweighted Average of Prices 6.2 A Budget-Share-Weighted Average of Prices 6.3 The Extended Model 6.4 A Two-Step Estimation Procedure: Step 1 6.5 A Two-Step Estimation Procedure: Step 2 6.6 AnExtension 6.7 Application of Stochastic Index Numbers to OECD and LDC 6.8 Conclusion References

189 190 193 194 196 199 205 224 224

CHAPTER 7: TESTING DEMAND THEORY HYPOTHESES: OECD AND LD COUNTRIES S. Selvanathan andE.A. Selvanathan

227

7.1

The Demand Model

228

7.2

Demand Homogeneity

230

7.3

Slutsky Symmetry

235

7.4 Summary Results References

241 245

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CHAPTER 8: A COMPARISON OF ALTERNATIVE DEMAND SYSTEMS £L4. Selvanathan andS. Selvanathan

249

8.1 Four Demand Systems 8.2 Measure of Goodness-of-fit 8.3 The Preferred Demand System 8.4 Conclusion References

250 256 259 264 265

CHAPTER 9: THE STRUCTURE OF PREFERENCES: OECD AND LD COUNTRIES S. Selvanathan andE^4. Selvanathan

267

9.1 The Demand Model 9.2 Model Estimation 9.3 Estimation Results 9.4 Testing Preference Independence 9.5 Implied Income and Price Elasticities 9.6 Conclusion References

268 270 273 279 285 291 292

APPENDIX: THE DEMAND ANALYSIS PACKAGE, DAP2000 ....295 Wana Yang, Kenneth W Clements and Dongling Chen A.l Using the Package A.2 InputOptions A.3 Preliminary Data Analysis A.4 Hypothesis Testing and Estimation A.5 The Matrix Approach to Simulation References

296 297 300 301 310 319

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INDEX Subject Index Author Index

321 321 324

xviii

LIST OF TABLES Chapter 1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9

General characteristics of the OECD and LD countries Economic characteristics of the OECD and LD countries Major studies in international consumption comparisons Characteristics of the LPW database Budget shares of eight commodities in 13 countries Prices and per capita quantities consumed of eight commodities in 13 countries Divisia moments in 13 countries Marginal shares and income elasticities for eight commodities in 13 countries Quality of budget share predictions in OECD countries and Australian states

4 5 15 18 19 20 21 23 25

Chapter 3 3.1 3.2 3.3 3.4

Details of the commodity groups Characteristics of the OECD database Budget shares of 9 commodities in 23 OECD countries Per capita quantity consumed of 9 commodities in 23 OECD countries 3.5 Prices of 9 commodities in 23 OECD countries 3.6 Divisia volume indices in 23 OECD countries 3.7 Divisia price indices in 23 OECD countries 3.8 Divisia quantity variances in 23 OECD countries 3.9 Divisia price variances in 23 OECD countries 3.10 Divisia price-quantity correlations in 23 OECD countries 3.11 Divisia moments in 23 OECD countries

72 73 75 77 79 80 82 84 85 86 88

3.12 Relative quantity log-changes of 9 commodities in 23 OECD countries 3.13 Relative price log-changes of 9 commodities in 23 OECD countries 3.14 Frequency distributions of relative consumption and relative prices of 9 commodities in 23 OECD countries 3.15 Frequencies of joint signs of relative consumption and relative price changes in 23 OECD countries 3.16 Estimates of Working's model for 23 OECD countries 3.17 Previous estimates of Working's income coefficient for food 3.18 Income elasticities of 9 commodities in 23 OECD countries 3.19 Own-price elasticities of 9 commodities in 23 OECD countries 3.20 Four sets of estimates for income flexibility in 23 OECD countries 3.21 Another set of estimates for income flexibility for OECD countries

90 91 92 93 99 101 103 104 107 114

Chapter 4 4.1 4.2 4.3 4.4

Details of the commodity groups Characteristics of the LDC database Budget shares of 9 commodities in 23 LD countries Per capita quantity consumed of 9 commodities in 23 LD countries 4.5 Prices of 9 commodities in 23 LD countries 4.6 Divisia volume indices in 23 LD countries 4.7 Divisia price indices in 23 LD countries 4.8 Divisia quantity variances in 23 LD countries 4.9 Divisia price variances in 23 LD countries 4.10 Divisia price-quantity correlations in 23 LD countries 4.11 Divisia moments in 23 LD countries 4.12 Relative quantity log-changes of 9 commodities in 23 LD countries

127 128 129 131 132 133 134 136 137 138 140 142

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4.13 Relative price log-changes of 9 commodities in 23 LD countries 4.14 Frequency distributions of relative consumption and relative prices of 9 commodities in 23 LD countries 4.15 Frequencies of joint signs of relative consumption and relative price changes in 23 LD countries 4.16 Estimates of Working's model for 23 LD countries 4.17 Income elasticities of 9 commodities in 23 LD countries 4.18 Own-price elasticities of 9 commodities in 23 LD countries 4.19 Four sets of estimates for income flexibility in 23 LD countries 4.20 Another set of estimates for income flexibility for LD countries

143 144 145 151 154 155 157 165

Chapter 5 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8

Average budget shares of 9 commodities: OECD and LD countries Average per capita quantity consumed of 9 commodities in OECD and LD countries Average prices of 9 commodities in OECD and LD countries Divisia moments in OECD and LD countries Average frequencies of joint signs of relative consumption and relative price changes in OECD and LD countries Estimates for income flexibility for the 9 commodities in 46 countries Average income elasticities of 9 commodities in OECD and LD countries Average own-price elasticities of 9 commodities in OECD and LD countries

171 173 173 175 177 180 181 181

Chapter 6 6.1 6.2

Estimates of price inflation and standard errors for Australia Estimates of relative price changes: Australia

202 204

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6.3

Rate of inflation estimates and their standard errors in 23 OECD countries 6.4 Rate of inflation estimates and their standard errors in 23 LD countries 6.5 Estimates of relative price changes for the 9 commodities in 23 OECD countries 6.6 Estimates of relative price changes for the 9 commodities in 23 LD countries 6.7 Quantity index estimates and their standard errors in 23 OECD countries 6.8 Quantity index estimates and their standard errors in 23 LD countries 6.9 Estimates of relative quantity changes for the 9 commodities in 23 OECD countries 6.10 Estimates of relative quantity changes for the 9 commodities in 23 LD countries

207 209 211 212 216 218 220 221

Chapter 7 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9

Further characteristics of the OECD database 232 Testing homogeneity in 22 OECD countries 234 Further characteristics of the LDC database 236 Testing homogeneity in 23 LD countries 237 Testing symmetry in 22 OECD countries 240 Testing symmetry in 23 LD countries 242 Summary results: Testing demand theory hypotheses in 22 OECD countries 243 Summary results: Testing demand theory hypotheses in 23 LD countries 244 Summary of percentage acceptance of the demand theory hypotheses: 22 OECD and 23 LD countries 245

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Chapter 8 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8

Value of the test statistics for testing homogeneity and the symmetry hypotheses for four demand models, OECD countries Summary results for testing homogeneity and symmetry for four demand models, OECD countries Value of the test statistics for testing homogeneity and symmetry hypotheses for four demand models, LD countries Summary results for testing homogeneity and symmetry for four demand models, LD countries Mean information inaccuracies, OECD countries Mean information inaccuracies, LD countries Preferred demand systems, OECD and LD countries Preferred demand systems for 22 OECD and 23 LD countries (in percentages)

252 253 254 255 261 262 263 264

Chapter 9 9.1

Estimates of the intercept terms of the model under preference independence for 9 commodities in 22 OECD countries 9.2 Estimates of the income coefficients for 9 commodities and income flexibility in 22 OECD countries 9.3 Estimates of the intercept terms of the model under preference independence for 9 commodities in 23 LD countries 9.4 Estimates of the income coefficients for 9 commodities and income flexibility in 23 LD countries 9.5 Testing preference independence in 22 OECD countries 9.6 Testing preference independence in 23 LD countries 9.7 Summary results: Testing preference independence, 22 OECD countries and 23 LD countries 9.8 Estimates of the income elasticities under preference independence for 9 commodities in 22 OECD countries 9.9 Estimates of the own-price elasticities under preference independence for 9 commodities in 22 OECD countries 9.10 Estimates of the income elasticities under preference independence for 9 commodities in 23 LD countries

274 275 277 278 280 281 284 287 288 289

xxm 9.11 Estimates of the own-price elasticities under preference independence for 9 commodities in 23 LD countries 9.12 Summary of acceptance of preference independence hypothesis: 22 OECD and 23 LD countries

290 291

Appendix A. 1 Overview of output of preliminary data analysis A.2 The comparison matrix A.3 Simulation procedure for M(k I j)

301 314 315

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LIST OF FIGURES Chapter 1 1.1

Food budget share vs logarithm of per capita GDP for 46 countries ..

7

Chapter 3 3.1

Quantity standard deviation vs price standard deviation in 23 OECD countries 3.2 Food budget shares against logarithm of per capita real consumption expenditures in OECD countries 3.3a Food budget share vs Log (Income) for pooled data from 23 OECD countries 3.3b Food budget share vs Log (Income) for pooled data from 22 OECD countries (excluding Iceland) 3.4 Relative quantity against relative price in OECD countries 3.5 Relative consumption vs relative prices for 9 commodity groups .... 3.6 Own-price elasticity against income elasticity

87 95 100 100 108 115 119

Chapter 4 4.1

Quantity standard deviation vs price standard deviation in 23 LD countries 4.2 Food budget share against logarithm of per capita real consumption expenditures in LD countries 4.3a Food budget share vs Log (Income) for pooled data from 23 LD countries 4.3b Food budget share vs Log (Income) for pooled data from 22 LD countries (excluding Hungary) 4.4 Relative quantity against relative price in LD countries 4.5 Relative consumption vs relative prices for 9 commodity groups .... 4.6 Own-price elasticity against income elasticity

139 147 152 152 158 163 167

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Chapter 5 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9

Average budget shares of 9 commodities, OECD vs LDC Average quantity log-changes in OECD and LD countries Average price log-changes in OECD and LD countries Quantity vs price standard deviations, 46 countries Relative consumption vs relative price in 46 countries Adjusted food budget share vs the logarithm of income - Pooled data from 44 countries Income elasticities of 9 commodities: OECD vs LD countries Own-price elasticities of 9 commodities: OECD vs LD countries Income elasticities vs own-price elasticities for 9 commodities in 46 countries

171 174 174 176 177 180 183 183 184

Chapter 6 6.1 6.2 6.3 6.4

Standard errors of the inflation estimates, Australia Estimated inflation rates vs their standard errors, Australia Estimated inflation rates vs their t-values, Australia Estimated inflation rates and their 95% confidence intervals, Australia 6.5 OECD inflation rates vs their standard errors 6.6 OECD inflation rates vs their t-values 6.7 LDC inflation rates vs their standard errors 6.8 LDC inflation rates vs their t-values 6.9 OECD quantity index estimates vs their standard errors 6.10 OECD quantity index estimates vs their t-values 6.11 LDC quantity index estimates vs their standard errors 6.12 LDC quantity index estimates vs their t-values

203 204 206 206 214 214 215 215 222 222 223 223

xxvi

TECHNICAL NOTES This book contains nine chapters and an Appendix. To aid the reader, each chapter has been written so that it is more or less self-contained. Each chapter contains a number of sections, subsections and a list of references. The sections in each chapter are numbered at two levels. The first level refers to the chapter and the second to the order of occurrence of the section within the chapter. For example, Section 2.4 is the fourth section in Chapter 2. Subsections are unnumbered. Equations are indicated by two numbers, the first refers to the section and the second to the order of occurrence within that section. For example, 'equation (2.8)' of Chapter 3 denotes the eighth equation in Section 2 of that chapter (Section 3.2). This equation is referred to in Chapter 3 as 'equation (2.8)'. If this equation is referred to in another chapter, then we use the terminology 'equation (2.8) of Chapter 3'. Tables and figures are indicated by two numbers, the first refers to the chapter and the second to the order of occurrence. For example, 'Table 4.5' refers to the fifth table of Chapter 4 and 'Figure 3.2' refers to the second figure of Chapter 3. Sections of the Appendix are numbered at two levels. For example, the second section of the Appendix is referred to as Section A2. Equations in the Appendix are numbered at three levels. For example, 'equation (A2.5)' refers to equation 5 of Section A2. Tables of the Appendix are numbered at two levels. For example, Table A.2 refers to the second table of the Appendix. Matrices are indicated by a boldface uppercase symbol (e.g., X). Vectors are indicated by a boldface lowercase symbol (e.g., x). The notation [xtJ] refers to a matrix whose (i,j)th element is xy, while x = [x,] refers to a column vector whose ith element is xt.

XXV11

ACKNOWLEDGEMENTS We wish to express our profound gratitude to Professor Ken Clements of the University of Western Australia for many stimulating discussions and helpful comments in writing the various chapters of the book, and for his encouragement and support. We would also like to thank Professor Clements and his colleagues Wana Yang and Dr Dongling Chen for their contribution of the User's Guide to the Demand Analysis Package, DAP2000, as an Appendix to this book. We are also grateful to Professor Prasada Rao of the University of New England for his invaluable comments on some of the chapters of the book. We also acknowledge the comments and suggestions of the anonymous reviewers and the editor of the book, which have helped improve the quality and presentation of the book. We would like to thank Dr Renuka Mahadevan, Mrs Tanya Tietze and Dr Nerissa Salayo for excellent research assistance during various stages of the project. We would also like to thank the publishing staff at World Scientific for their patience and support throughout the duration of the project. Finally, we acknowledge the financial support of an ARC (Small) grant, Griffith University, in assisting with the data collection and preliminary analysis. Our special thanks to our loving children, Arthavan (11 yrs) and Prabha (9 yrs), for their patience, support and clerical assistance throughout the duration of this project.

CHAPTER 1

An Overview of International Consumption Patterns £L4. Selvanathan 14yrs 15-64yrs 65-yrs (1)

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OECD Countries English, Aboriginal 19.40 7713.36 Anglican, Romm Catholic 1. Australia German ai3 Roman Catholic Anglican 83.85 2. Austria 10.24 Roman Catholic Dutch, French, German 30.52 3. Belgium 31.28 9976.14 Roman Catholic, Protestant English French, Inuktitut 4. Canada 5.34 Danish 43.09 Lutheran 5. Denmark Finnish, Swedish 5.17 Frotestant 338.13 Finland 6. French 59.33 551.50 Roman Catholic Frotestant, Islam 7. France Gerrran 82.80 Lutheran, Roman Catholic 356.91 8 Germany Greek 10.60 Greek Orthodox 131.99 Greece 9. Icelandic 0.28 Lutheran 103.00 10. Iceland Roman Catholic Fbtestant Irish English 3.80 70.28 11. Ireland Italian 57.63 301.27 Roman Catholic 12. Italy Japanese, Korean, Chinese Shinto, Buddhist, Christian 126.55 377.80 13. Japan Letzburgish, French, Gerrran 0.44 Roman Catholic 2.59 14. Luxembourg Dutch, Frysian 15.89 37.33 Roman Catholic Frotestant 15. Netherlands New Zealand English, Maori 3.82 Anglican, Romm Catholic Presbyterian 270.99 16. 4.48 Norwegian 323.90 Lutheran 17. Norway Portuguese Rorran Catholic 10.05 92.39 18. Portugal Catalan Roman Catholk 40.00 504.78 19. Spain Swedish a87 Lutheran, Frotestant 449.96 20. Sweden 7.26 Romanist 41.29 Roman Catholic FTOtestant 21. Switzerland English, Welsh, Scottish, Irish 59.51 244.88 Frotestant, Roman Catholk, Islam. Hindu, Judaism 22. UK English, Spanish 275.56 Frotestant, Roman Catholkjudaism 9372.61 23 US LD Countries 39.69 Roman Catholk: Spanish Colombia 1138.91 1. 0.76 Greek Orthodox, Christian, Islam Greek, Turkish 9.25 Cyprus 2. Roman Catholic 12.92 Spanish, Cuediua 283.56 3. Ecuador 0.83 1&27 English, Fijian, Hndi Christian, Wndu 4. Fiji Roman Catholic 6.25 112.09 Spanish, English 5. Honduras 7.12 Buddhist, Confucian, Taoist, Christian, Islam Hindu English, Chinese Hong Kong 1.04 6. 10.14 Hungarian 93.03 Roman Catholic Frotestant 7. Hungary 1014 Ffindu, Islam Sikh, Christian Ffndi, English, Tanil 3287.59 8. India 65.62 Farsi, Turkic Kurdish 1648 Islam Christian 9. Iran 5.84 Hebrew, Arabk 20.77 JeiMsh, Islam 10. Israel 2.65 10.99 Frotestant, Romm Catholk English 11. Jamaica 47.47 99.02 Buddhist, Protestant, Roman Catholic Confudanist Korean 12. Korea 0.39 0.32 Rorran Catholk Maltese, English 13. Malta Roman Catholic Spanish 100.35 1958.2 14. Mexico 81.16 300 Roman Catholic Islam Filipino, English Spanish 15. Philippines Romm Catholic ftotestant Spanish, English 3.92 8.9 16. Puerto Rico Chinese, hfelay, Tanil, English Buddhist, Christian, Islam Taoist, Hindu 4.15 17. Singapore 0.62 Africaans, English, Xhosa, Zulu Christians, Ftoman Catholic 43.42 1221.04 18. South Africa 19.24 Buddhist, Hindu, Islam Christian Sinhalese, Tanil, English 65.61 19. Sri Lanka Buddhist, Confucian, Taoist, christian 22.19 35.74 Chinese, Taiwanese 20. Taiwan Thai, Chinese, Malay 61.23 513.12 Buddhist, Islam 21. Thailand Romm Catholic Spanish 23.54 22. \fenezuela 912.05 11.34 English, Bantu 390.58 Christian, Anirrist 23. Zimbabwe Source: The Wforld Fact Book', wm.ofa.gotJa^fxMi&tians/fdctixxi^ and US Bureau of the Census, International Database.

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(7)

(8

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21 17 17 19 19 18 19 16 15 23 22 14 15 19 18 22 20 17 15 18 17 19 21

67 68 66 68 67 67 65 68 67 65 67 68 68 67 68 66 65 67 68 65 68 65 66

12 15 17 13 15 15 16 17 18 12 11 18 17 14 14 12 15 16 17 17 15 16 13

2.52 96.96 335.52 3.14 123.93 15.29 107.58 231.99 80.31 2.72 54.07 191.29 334.97 169.88 425.66 14.10 13.83 108.78 79.24 19.71 175.83 243.02 29.40

32 23 36 33 42 18 17 33 33 27 30 22 20 33 37 24 18 32 26 21 23 32 39

63 66 60 63 54 72 69 62 62 63 63 71 67 62 59 66 75 63 67 70 70 63 58

5 11 4 4 4 11 15 5 5 10 7 7 13 5 4 10 7 5 7 9 7 5 3

34.85 82.15 45.56 45.43 55.76 6846.15 109.00 308.43 39.82 281.17 241.13 479.40 1218.75 51.25 270.53 440.45 6693.55 35.56 293.25 620.87 119.33 25.81 29.03

5

Chapter 1 An Overview Table 1.2 Economic characteristics of the OECD and LD countries

(1) OECD Countries 1. Australia 2. Austria 3. Belgium 4. Canada 5. Denmark 6. Finland 7. France 8. Germany 9. Greece 10. Iceland 11. Ireland 12. ItaJy 13. Japan 14. Luxembourg 15. Netherlands 16. New Zealand 17. Norway 18. Portugal 19. Spain 20. Sweden 21. Switzerland 22. UK 23. US LD 1. 2. 3.

Countries Colombia Cyprus Ecuador

Inflation Unemployment

Major Trading Partners

Country

Export

Import

(2)

(3)

Japan, US, Korea USJapan, China Germany, Italy, Switzerland Germany, Italy, Switzerland France, German/, Netherlands Netherlands, Germany, France US. Japan, UK Us Japan, China Germany, Sweden, UK Germany, Sweden, UK Germany, Sweden, Russia Germany, Sweden, UK Germany, Belgium, Italy Germany, UK Spain France, Nethedands, US France. US, UK Italy, Germany, France Germany, Italy, UK Germany, US, UK UK. Germany, US UK US, Germany UK, US, Germany Germany, France, US Germany, France, Netherlands US, China, Korea US, China, Korea Belgium, Germany, France Germany, France, Belgium Germany, US, UK Germany, Belgium, France Australia, USJapan Australia US, Japan UK, Netherlands, France Sweden Germany, UK Spain, Germany, France Spain Germany, France France, Germany, Italy France, Germany, Portugal Germany, UK Norway Germany, US, UK Germany, France, Italy Germany, US, France Germany, US. France US, Germany, France Canada, Mexico, Japan Canada, Mexico, Japan

2000 (4) 4.50 2.40 2.50 2.70 2.90 3.40 1.70 1.90 3.10 5.20 5.60 2.50 •0.70 2.90 2.50 2.70 3.10 2.90 3.40 1.00 1.50 2.90 3.40

Real per capita GDP in 1992

2000

inSUS

US-100

locXGDP)

(5)

(6)

(7)

(8)

6.3 3.70 10.90 6.80 5.40 9.80 9.50 10.50 11.40 1.30 4.10 10.50 4.70 2.70 2.60 6.00 3.40 4.00 14.10 4.70 2.00 5.50 4.00

18500 16989 18091 20970 18730 15619 18232 20197 8658 16324 12259 16724 19920 21144 17373 15502 17094 9005 12986 18387 21631 16302 23220

80 73 78 90 81 67 79 87 37 70 53 72 86 91 75 67 74 39 56 79 93 70 100

9.83 9.74 9.80 9.95 9.84 9.66 9.81 9.91 9.07 9.70 9.41 9.72 9.90 9.96 9.76 9.65 9.75 9.11 9.47 9.82 9.98 9.70 10.05

Food budget share 1992 (9) 0.20 0.19 0.18 0.16 0.21 0.24 0.18 0.21 0.36 0.25 0.33 0.20 0.19 0.19 0.15 0.19 0.22 028 0.20 0.20 0.27 0.21 0.12

4254 0.34 8.36 18 16.70 8.00 US, Venezuela, Ecuador US, Venezuela Mexico 9.37 51 11742 3.40 UK Greece, Russia 0.26 4.10 UK US, Italy 8.14 15 3420 10.30 96.10 US, Colombia, Venezuela US, Korea, Colombia 0.39 8.57 S288 Australia, re, Singapore 0.37 23 6.00 1.10 Australia, US, UK 4. Fiji 7.49 8 1792 28.00 11.00 US, Guatemala Japan US, Germany, Belgium 5. Honduras 0.45 21034 9.95 91 5.10 -3.80 China Taiwan Japan China, US, Japan 6. Hong Kong 0.16 866 0.37 25 5780 6.40 9.80 Germany, Samoa, Italy Germany, Russia Italy 7. Hungary 7 7.40 1633 4.40 4.00 US, Hong Kongjapan 8. India 0.53 US, Belgium Singapore 8.33 18 4161 14.00 14.50 Germany, Korea, Italy Japan, Italy, Korea 9. Iran 0.35 9.46 US, Belgium, Germany 0.24 55 12783 8.80 1.10 US, Belgium UK 10. Israel US, UK, Canada US, UK Canada 0.41 8.00 13 2978 16.00 8.80 11 .Jamaica 9.14 4.00 Japan, US, China 0.30 40 9358 2.30 US, Chinajapan 12. Korea 8.94 France, Italy, Singapore US, Singapore, Germany 0.31 33 7625 5.30 2.40 13 Malta US, Canada, Germany 8.97 34 7867 2.20 9.50 US, Japan, Germany 14. Mexico 0.28 2172 Japan, US, Korea USJapan, Taiwan 15. Philippines 0.58 7.68 9 11.00 4.30 8.87 31 US, Dominican, Netherlands US, lreland,japan 0.22 7120 9.50 5.70 16. Puerto Rico 72 17. Singapore 0.17 9.73 16736 3.00 1.40 Malaysia, USJapan Malaysia US, Hong Kong 8.26 17 3885 30.00 5.30 Germany, US, UK US, UK Japan 18. South Africa 0.36 7.93 12 19. Sri Lanka 0.59 2783 7.60 6.20 Japan, India Hong Kong US, UK Germany 9.20 42 9850 3.00 1.30 Japan, US, Korea US, Hong Kongjapan 0.28 20. Taiwan 8.52 Japan, US, China USJapan, Singapore 21. Thailand 22 5018 3.60 1.60 0.29 9.04 36 8449 US, Colombia, Brazil US, Nethedands, Brazil 22. Venezuela 0.41 13.90 16.20 South Africa UK Japan 23. Zimbabwe 7.30 6 1479 50.00 55.70 South Africa UK, Mozambique 0.30 Source: Columns 2-5 are based on year 2000 trade figures obtained from FACT sheet, Department ofForeign Affairs and Trade, Australia. GDP are from Perirvorld Tables by Heston and Summers. For Honduras, the entries are from The World Fact Book', vwiw.cxfci.Q^x^da/puHications/factbook; and GDP and budget share entries for Puerto Rico are for 1985 and for Taiwan are for 1990.

6

International Consumption Comparisons

OECD countries enjoy a lower rate of inflation combined with a lower rate of unemployment, the LD countries have a much higher rate of inflation coupled with a higher rate of unemployment, with the exception of the four Asian Tigers, namely, Hong Kong, Singapore, Korea and Taiwan. Column 6 of Table 1.2 gives the real per capita GDP (for the year 1992). As can be seen, among the LD countries, the per capita GDP of Hong Kong and Singapore are comparable with many OECD countries and are even higher than some of the OECD countries (for example, Greece and Portugal). For ease of comparison, in column 7, we present the GDP with US=100. Column 8 presents the logarithm of real per capita GDP for all countries. The last column of the table gives the food budget share for the 46 countries. Comparing columns 7 and 9, we can see an inverse relationship between the per capita real GDP and the food budget share. That is, the food budget share decreases with increasing real GDP. This is illustrated in Figure 1.1, where we plot the food budget share against the logarithm of per capita real GDP. As can be seen, a clear inverse relationship exists between food budget share and the per capita real GDP. This observation supports the famous law in consumption economics, the Engel's Law, which states that food budget share falls with increasing income. More on Engel' s law will be discussed in the later chapters.

1.2

Consumption Theory

The objective of consumption theory is to analyse the demand for goods and services in terms of income and prices. In Chapter 2, we present a detailed description of consumption theory. In this section, we present a simplified description of this theory.

Chapter 1 An Overview

y = -0.1196x+ 1.3748

Food budget share o o ro *.

0.6 -

^ $ * >

0.0 8

9

10

Ln(GDP per capita)

Food budget share vs logarithm of per capita GDP for 46 countries Figure 1.1

Consider a demand function for commodity i of the form M log # = a + P log —-1 + y log vP \Pj

(2.1)

where q-x is the quantity consumed of i; M is the consumer's money income; P is a general price index; pt is the price of i; and a, P and y are constants. The coefficient P in equation (2.1) is interpreted as the income elasticity, i.e.,

8

International Consumption Comparisons 8(log g| .)

T og yJ This elasticity describes the income sensitivity of consumption of the good. The coefficient y is the price elasticity of demand, i.e., dflogg,) '

< * * ) '

As demand curves slope downwards, this elasticity is negative. The income variable in equation (2.1) is money income (M) deflated by the general price index (P). Thus MIP is interpreted as real income. As real income is being held constant, if p/P changes, then the response of consumption to this change reflects the pure substitution effect only. As the coefficient y measures this response, it is known as the "income-compensated" price elasticity, or the compensated price elasticity for short. The size of y reflects the availability of substitutes; y will be higher (in absolute value) when there are more good substitutes available. As the two variables on the right-hand side of equation (2.1) are both expressed in real terms (real income and the relative price of i), it follows that an equi-proportional increase in the nominal variables M, p± and P has no effect on consumption. This property of the demand equation is known as the absence of money illusion of the consumer, or demand homogeneity (as the demand equation is homogeneous of degree zero in nominal variables). The key virtue of model (2.1) is its simplicity. Its parameters have a straightforward economic interpretation and the model can be easily estimated. However, it suffers from several deficiencies. The first problem is that it does

9

Chapter 1 An Overview

not give any explicit attention to consumer preferences, which lie behind the demand equation. Second, the model deals with the demand for commodity i in isolation from all other goods. The model consists of only one equation whereas in fact there is one equation for each of the n goods consumed. A related deficiency is that the model does not allow good i to be more closely related to some goods and less to others. This is because the model specifies that all crossprice elasticities d(logg,-)

i*j.

logy are zero. A simple way of rectifying the second deficiency is to extend model (2.1) by adding to it terms involving the prices of other goods. Let there be n goods with prices p\,..., p„. An extended version of (2.1) is then M log qx = a; + PJ log —

+ £ Ytj log

i=l,...,n.

In model (2.2) the coefficient pi is the income elasticity (as before) and aqogg,.)

n = —r

log

Pj

(2.2)

International Consumption Comparisons

10

is the compensated elasticity of demand for good i with respect to the price of good j . It is to be noted that (2.2) consists of n equations, which describe the demand for the n goods simultaneously. Accordingly, (2.2) is a 'system-wide' demand model (Theil, 1980). As p,qi is expenditure on good i, expenditure on all n goods is X"=i p,- 1). Notwithstanding its popularity, LES has its drawbacks. Perhaps the most important is the parameterization whereby the marginal shares are treated as constants. It is clear from (4.1) that the constancy of the marginal share implies that the income elasticity is inversely proportional to the corresponding budget share. This can give rise to problems when income is subject to large changes.

1.5

Are Tastes Constant?

One of the other areas where consumer demand analysis is gaining significance is the argument that consumer tastes are the same or similar across countries. In

Chapter 1 An Overview

23

Table 1.8 Marginal shares and income elasticities for eight commodities in 1 3 countries

Country

o U-

u

I

a

CL

H

(5)

(6)

(7)

(8)

0.14 0.05 0.13 0.03 0.07 0.07 0.1 1 0.01 0.05 0.05 0.04 0.05 0.07

0.1 7 0.25 0.22 0.28 0.12 0.12 0.18 0.17 0.1 1 0.21 0.09 0.12 0.15

0.07 0.10 0.01 0.07 0.12 0.07 0.14 0.08 0.08 0.05 0.13 0.15 0.08

0.1 1 0.02 0.14 0.1 1 0.10 0.02 0.07 0.07 0.03 0.06 0.02 0.03 0.04

0.07

0.17

0.09

0.06

1.69 1 .41 2.33 1.30 1.00 1.05 1.65 1.08 1.33 1.02 0.94 0.93 1.76

1.1 5 1.78 1.71 2.54 1.59 1.44 1.43 1.93 1.55 1.56 0.90 1.56 3.1 1

1.18 1.09 0.21 0.88 1.44 0.93 1.56 1.19 1.36 0.98 1.69 2.00 1.77

2.31 1.00 1.14 2.65 0.97 1.06 1.95 1.19 1.22 1.44 0.83 1.56 1.73

1.35

1.71

1.25

1.46

(2)

(3)

(4)

Israel Italy 7. Puerto Rico Ireland 8. Greece 9. 1 0 . South Africa 1 1. Panama 1 2 . Thailand 1 3 . Korea

0.09 0.28 0.14 0.12 0.21 0.40 0.18 0.32 0.34 0.30 0.42 0.48 0.43

0.1 1 0.07 0.05 0.07 0.10 0.09 0.1 1 0.13 0.17 0.16 0.08 0.10 0.07

0.21 0.1 5 0.22 0.26 0.17 0.17 0.14 0.1 1 0.18 0.07 0.1 1 0.01 0.09

0.1 1 0.08 0.08 0.08 0.12 0.07 0.07 0.1 1 0.05 0.12 0.1 1 0.05 0.08

Mean

0.29

0.10

0.14

0.09

1.

US

2.

Sweden Australia

0.34 0.76 0.43 0.30 0.66 0.87 0.50 0.64 0.73 0.80 0.92 0.84 0.73

1 .14 0.62 0.46 0.63 1.10 0.86 1.06 1.34 1.38 1.39 1.10 1.20 0.66

0.91 0.91 1.73 1.41 0.90 1.03 0.94 0.84 0.96 0.40 0.68 0.16 0.75

1.45 1.13 1.05 1.1 5 1.61 2.16 0.99 2.00 1.28 1.47 1.77 1.63 2.75

0.65

0.99

0.89

1.57

(1)

O (9)

M arginal shares 1.

US

2. 3.

Sweden Australia

4.

UK

5. 6.

Income elasticities

3. 4.

UK

5.

Israel Italy Puerto Rico Ireland Greece South Africa Panama Thailand Korea

6. 7. 8. 9. 10. 11. 12. 13.

Mean

Source: Marginal shares are from Lluch et al. (1977, Table 3.6) and income elasticities are derived using equation (4.1).

24

International Consumption Comparisons

this section we present some cross-country and regional results directly from Clements and Selvanathan (1994, Sec. 8), which originated from the work of Selvanathan (1993, Chapter 4). In a highly-influential paper, Stigler and Becker (1977) advocates treating tastes as fixed. Their argument has merit as the utility maximization theory usually postulates that tastes are fixed, so that it is only the observable variables income and prices that explain consumption. Stigler and Becker show that a number of examples of apparently capricious behaviour (addiction, custom, tradition, fashion etc.) can in fact be reconciled with the assumption of stable preferences. Stigler and Becker (p.89) argue that, "no significant behaviour has been illuminated by the assumption of differences in tastes. Instead, they, along with the assumption of unstable tastes, have been a convenient crutch to lean on when the analysis has bogged down. They give the appearance of considered judgement, yet really have only been ad hoc arguments that disguise analytical failures." Selvanathan (1993, Chapter 4) carried out an analysis to test the hypothesis of stable preferences by estimating demand equations for different groups of consumers and then analysing the extent to which the parameters (such as the income and price elasticities) differ across consumers. Selvanathan performed the analysis with the OECD database (consisting of 15 countries with 10 commodity groups) by estimating (i) country-specific demand equations; and (ii) common demand equations for all countries whereby the data are pooled across countries. The test then involved an analysis of the deterioration in the fit of the demand equations when the data are pooled. In other words, this amounted to investigating the extent to which the same demand equations can explain consumption in the different OECD countries. The upper part of Table 1.9 contains the results using the root-meansquared (RMS) percentage prediction error as the goodness-of-fit criterion for

25

Chapter 1 An Overview

Table 1.9 Quality of budget share predictions in OECD countries and Australian states RMS percentage prediction error Country (1) OECD Countries 1. US 2. Canada 3. Sweden 4. Denmark 5. Australia 6. France 7. Belgium 8. Norway 9. Netherlands 10. Iceland 11. Finland 1 2. Austria 13. UK 14. Spain 1 5. Italy

Weight (xl 00) (2)

51.34 5.14 1.84 1.01 2.74 10.30 1.81 .72 2.42 .04 .82 1.25 8.57 4.78 7.20

16. Unweighted mean 1 7. Weighted mean Australian states 18. NSW 1 9. Victoria 20. Queensland 21. SA 22. WA 23. Tasmania 24. U n w e i g h t e d mean 25. W e i g h t e d mean

38.53 27.31 14.79 8.29 8.47 2.61

Individual country/state (3)

Pooled country/state (4)

1.65 3.16 1.88 2.16 2.41 1.39 2.59 2.07 3.20 4.70 3.68 2.34 1.77 2.33 1.88

1.72 3.32 1.91 2.16 2.46 1.39 2.74 2.35 3.58 4.99 3.67 2.50 1.79 2.29 2.13

2.48 1.87

2.60 1.95

2.16 2.49 3.07 2.47 2.54 3.42

2.14 2.59 2.97 2.51 2.46 3.56

2.69 2.47

2.70 2.48

The column 2 weights for the OECD countries are proportional to GDPs in 1975 in international dollars; and the weights for the Australian states are proportional to total consumption expenditures in 1981. The RMS percentage prediction errors in columns 3 and 4 are 100 times the square root of the budgetshare-weighted mean of the squared relative prediction errors of the budget shares; as an approximation, these are computed as 100 times the square root of twice the information inaccuracies.

26

International Consumption

Comparisons

the 15 OECD countries. Although the RMSEs for the country-specific models (given in column 3) are in general a bit lower than those for the pooled model (column 4), the differences are not substantial. In addition, the countries have similar rankings with respect to the two sets of RMSEs. Looking at the entries in row 17 of columns 3 and 4 of Table 1.9, the weighted means of the RMSEs are 1.87 percent for the individual country models and 1.95 percent for the pooled model. Accordingly, the average "cost" of taking tastes to be identical is 1.95 - 1.87 = .08 percentage points. This is clearly quite modest and points in the direction that tastes are not too dissimilar across countries. (For a different finding, however, see Pollak and Wales, 1987.) There are many non-economic differences between some of the OECD countries (see Tables 1.1 and 1.2). For example, language, culture and climate differ substantially in some cases. It may thus come as a surprise to some that tastes in these countries are more or less similar. In an attempt to control for some of the non-economic factors, Selvanathan and Selvanathan (1994, Chap.4) conducted a similar analysis with data from different regions of the same country, the six states of Australia. The lower part of Table 1.9 summarizes the findings and the result is that tastes are even more similar within a country, as expected.

References Chen, D.L. (2001). World Consumption Economics. Singapore, London: World Scientific. Clements, K.W., and S. Selvanathan (1994). "Understanding Consumption Petterns,' Empirical Economics 19: 69-110.

Chapter 1 An Overview

27

Clements, K.W., and H. Theil (1996). 'A Cross-Country Analysis of Consumption Patterns,' Chapter 7 in H. Theil (ed.), Studies in Global Economics. Advanced Studies in Theoretical and Applied Econometrics, Boston: Kluwer Academic Publishers, 95-108. Deaton, A.S. (1975). Models and Projections of Demand in Post-War Britain. London: Chapman and Hall. Gamaletsos, T. (1973). 'Further Analysis of Cross-Country Comparison of Consumer Expenditure Patterns,' European Economic Review 4: 1-20. Goldberger, A.S., and T. Gamaletsos (1970). 'A Cross-Country Comparison of Consumer Expenditure Patterns,' European Economic Review 1: 357-400. Houthakker, H.S. (1957). 'An International Comparison of Household Expenditure Patterns, Commemorating the Centenary of Engel's Law,' Econometrica 25: 532-551. Houthakker, H.S. (1965). 'New Evidence in Demand Elasticities,' Econometrica 33: 277-288. Kravis, LB., A.W. Heston and R. Summers (1978). International Comparisons of Real Product and Purchasing Power. Baltimore, Md.: The John Hopkins University Press. Kravis, I.B., A.W. Heston and R. Summers (1982). World Product and Income: International Comparisons of Real Gross Product. Baltimore, Md.: The John Hopkins University Press. Lluch, C. (1973). The Extended Linear Expenditure System,' European Economic Review 4: 21-32. Lluch, C, and A.A. Powell (1975). 'International Comparisons of Expenditure Patterns,' European Economic Review 5: 275-303. Lluch, C, A.A. Powell and R.A. Williams (1977). Patterns in Household Demand and Saving. Oxford: Oxford University Press.

28

International Consumption Comparisons

Lluch, C, and R.A. Williams (1975). 'Cross Country Demand and Savings Patterns: An Application of the Extended Linear Expenditure System,' Review of Economics and Statistics 57: 320-328. Parks, R.W. (1969). 'Systems of Demand Equations: An Empirical Comparison of Alternative Functional Forms,' Econometrica 37: 629-650. Parks, R.W., and A.P. Barten (1973). 'Cross-Country Comparison of the Effects of Prices, Income and Population Composition on Consumption Patterns,' Economic Journal 83: 834-852. Pollak, R.A., and TJ. Wales (1969). "Estimation of the Linear Expenditure System,' Econometrica 37: 611-628. Pollak, R.A, and T.J. Wales (1987). Pooling International Consumption Data,' Review of Economics and Statistics 69: 90-99. Pollak, R.A., and T.J. Wales (1992). Demand System Specification and Estimation. New York and Oxford: Oxford University Press. Selvanathan, S. (1988). A System-Wide Analysis of International and Interregional Consumption Patterns. Ph.D. Thesis, The University of Western Australia. Selvanathan, S. (1993). A System-Wide Analysis of International Consumption Patterns. Advanced Studies in Theoretical and Applied Econometrics, Boston: Kluwer Academic Publishers. Selvanathan, S., and E.A. Selvanathan (1994). Regional Consumption Patterns: A System-Wide Approach. London: Avebury Publishers. Stigler, A.J., and A.S. Becker (1977). 'De Gustibus Non Est Disputandum,' American Economic Review 67: 76-90. Stone, R. (1954a). The Measurement of Consumers' Expenditure and Behaviour in the United Kingdom, 1920-1938. Vol. 1, Cambridge: Cambridge University Press. Stone, R. (1954b). 'Linear Expenditure Systems and Demand Analysis: An Application to the Pattern of British Demand,' Economic Journal 64: 511527.

Chapter 1 An Overview

29

Theil, H. (1980). The System-Wide Approach to Microeconomics. Chicago: The University of Chicago Press. Theil, H. (1987). 'The Economics of Demand Systems,' Chapter 3 in H. Theil and K.W. Clements (eds.), Applied Demand Analysis: Results from System-wide Approaches. Cambridge, MA: Ballinger Publishing Company. Theil, H., and F.E. Suhm (1981). International Consumption Comparisons: A System-wide Approach. Amsterdam: North-Holland Publishing Company. Theil, H., D.L. Chen and C. Moss (1996). Studies in Global Econometrics. Boston: Kluwer Academic Publishers. Yoshihara, K. (1969). Demand Functions: An Application to the Japanese Expenditure Pattern,' Econometrica 37: 257-274.

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CHAPTER 2

Consumer Demand Models E.A. Selvanathan | is expected to be negative. If preferences are of the form (2.1), the (ij)* price elasticity then becomes (see, e.g., Clements et al, 1995):

41

Chapter 2 Consumer Demand Models Tly =

(3 4)

-

where dq/dp' = [dqjdpj] is the n x n matrix of price derivatives of the demand functions and dq/dM = [dq\/dM] is the vector of n income slopes of the demand functions. Differentiating (1.6) with respect to/?j and M, we get

46

International Consumption Comparisons "

d u

dqk

k=l dqtdqk

=

dpj

, ,, dX h&ij + Pi dPj'

i,j=l,...,w,

(3.5)

i=l,...,n.

(3.6)

where 5;, is the Kronecker delta, and d2u

«

dqk

k=\ dqidqk

Pi

dM

dX dM'

We write (3.5) and (3.6) in matrix form as U

,_ dX XI + p——

dq dp'

(3.7)

and U

dX

dq dM

dM

(3.8)

P,

where U is the Hessian matrix defined below (1.7). I is the n x n identity matrix and dX/dp' = [dMdpfi. Combining (3.3), (3.4), (3.7) and (3.8), we get U

dq

dq

p

dM

dp'

O

dX

dX

dM

dp'

0

XI (3-9)

p'

1

-q

The above matrix equation is known as Barten's Fundamental matrix equation in consumption theory (Barren, 1964).

Chapter 2 Consumer Demand Models

Al

If we solve equation (3.9) with respect to the first-order derivatives, we obtain the solutions

dM

(3.10)

p'U~xp

—^-U-xp(V-1py--^-rV-lpq', p U p p U p

dp'

(3.11)

dA dM

(3.12) p'U^p'

and dA dp

A l

p'U p

U

. P

1 Tl T T T - ^ p'U p

(3.13)

where we have also used U

-l

1

(p'u-lP)U'1 -u-'pifj-'py

p'U'p

u'p

(u-'py

-l

Now, we return to equation (1.5), the Marshallian demand equation for good i. The differential of (1.5) is given by (e.g. Theil and Clements, 1987; and Selvanathan and Clements, 1995): dq,

a 8^ = ~^dM + £ 9iZ^-dp:, dM j=idpj

i=l,...,n.

48

International Consumption Comparisons

If we multiply both sides of the above equation by p-JM, it can be transformed into the form

wid(logqi) = Qid(logU) + i^p^d(logpj), 7=1 M

dpj

J

i=l,...,n.

(3.14)

Relative Price Version

Using equations (3.10)-(3.13) and (3.14), we can easily derive the following simplified demand equations in relative prices: wi d(log q-d = 6i d(log Q) + £ v dlog EL y=i F

i=l,...,n,

(3.15)

where 0j = w\f\t is the i* marginal share; d(log Q) = d(log M) - d(log P) = X"=i Wjd( log qt), is the Divisia volume index of the change in the consumer's real income; d[log (p/P')] is the change in the deflated price of j with d(log P') = X°=i#jd(log p.) is the Frish price index: and Vy = (k/M)piu''pj is the (ij)"1 price coefficient, with X the marginal utility of income and u'1 the (ij)* element of the inverse of the Hessian of the utility function, U = [d2u/dq,dqj\. Note that the coefficients 9j and Vy are not necessarily constant. The price coefficients, Vy, satisfy Z^i^y = 0i, i=l, ....,«, where <j) is the income flexibility, defined in Section 2.2. Equation (3.15) above is the i'h demand equation of the relative price version of Their s (1980) differential demand system. The first term on the right of (3.15) gives the effect of real income on the demand for goodi. This term is a multiple Q, of the Divisia volume index d(log g). As this volume index equals d(log M) - d(log P), where d(log P) is the Divisia price index, it follows that the Divisia price index transforms the change in money income into the change in real income. Furthermore, as the Divisia

49

Chapter 2 Consumer Demand Models

price index is budget-share-weighted, it follows that this index measures the income effect of the n price changes on the demand for the i* good. The second term on the right of (3.15), EjLiVjjdTlogCpj IF)], deals with the effects of relative prices. The Frisch price index acts as a deflator of each price change, so that we refer to d[log (p/P1)] as the change in the Frisch-deflated price of j . Using the fact that Z;=i v y =¥*i> it c a n be shown that the substitution term can be written as the difference between X"=i Vjjd(log Pj), which is the specific substitution effect of the n prices on the demand for good i, and 6id(log P') is the general substitution effect. Accordingly, the general substitution effect acts as the deflator of the specific effect by transforming absolute prices into Frisch-deflated prices. If Vy > 0, then an increase in the Frisch-deflated price of j causes consumption of i to increase. Consequently, we follow Houthakker (1960) and define goods i and j as specific substitutes (complements) if Vy > 0 (< 0). Absolute Price Version

Equation (3.15) is formulated in terms of relative (or deflated) prices. The corresponding absolute price version is

Wid(log^)

n = 9id(log