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Omitted budget constraint bias in discrete-choice demand models

Pesendorfer, M., Schiraldi, P. & Silva Junior, D. ORCID: 0000-0002-0706-0802 (2023). Omitted budget constraint bias in discrete-choice demand models. International Journal of Industrial Organization, 86, 102889. doi: 10.1016/j.ijindorg.2022.102889

Abstract

A large body of discrete-choice demand studies estimate a demand model in which the consumer’s budget constraint is not taken into account. We illustrate how incorrectly specifying the consideration set, when in fact the budget constraint binds for some products, may bias the demand estimates. We illustrate and quantify the nature of the bias in three ways: (i) in analytical examples; (ii) in field data commonly used in the literature and (iii) in a Monte Carlo study. We find that the price sensitivity can be substantially lower when correctly imposing the budget constraint, and own-price elasticities are typically overestimated although the direction of the own-price elasticity bias is in general ambiguous and depends on the income distribution.

Publication Type: Article
Additional Information: © 2022 The Author(s). Published by Elsevier B.V. This is an open access article under the CC BY license (http://creativecommons.org/licenses/by/4.0/).
Publisher Keywords: Omitted budget constraint bias, Discrete choice demand, Automobile industry
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HD Industries. Land use. Labor
H Social Sciences > HM Sociology
Departments: School of Policy & Global Affairs > Economics
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