Demand systems incorporating intertemporal consumption dynamics

This paper integrates two strands of studies on consumer demand and consumption and evaluates the relevance of the traditional approach for analyzing consumer behavior employing an intertemporal two-stage budgeting procedure. We take a modified AIDS framework for the demand system and derive a general Euler equation by allowing for life-cycle behavior and precautionary saving. We also investigate excess sensitivity and habit formation in consumption behavior. The demand system and the Euler equation constitute a system of recursive equations with cross-equation parameter restrictions. Joint estimation of the demand system and the Euler equation can lead to substantial efficiency gains. Separate or sequential estimation tends to bias parameter estimates and the degree of risk aversion and intertemporal substitution.