Journal Article

Deep Habits

Morten Ravn, Stephanie Schmitt-Grohé and Martín Uribe

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 73, issue 1, pages 195-218
Published in print January 2006 | ISSN: 0034-6527
Published online January 2006 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2006.00374.x
Deep Habits

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  • Household Behaviour and Family Economics
  • Macroeconomics: Consumption, Saving, Production, Employment, and Investment

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This paper generalizes the standard habit-formation model to an environment in which agents form habits over individual varieties of goods as opposed to over a composite consumption good. We refer to this preference specification as “deep habit formation”. Under deep habits, the demand function faced by individual producers depends on past sales. This feature is typically assumed ad hoc in customer-market and brand-switching-cost models. A central result of the paper is that deep habits give rise to countercyclical mark-ups, which is in line with the empirical evidence. This result is important, because ad hoc formulations of customer-market and switching-cost models have been criticized for implying procyclical and hence counterfactual mark-up movements. Under deep habits, consumption and wages respond procyclically to government-spending shocks. The paper provides econometric estimates of the parameters pertaining to the deep-habit model.

Keywords: D11; D12; E21

Journal Article.  11468 words.  Illustrated.

Subjects: Household Behaviour and Family Economics ; Macroeconomics: Consumption, Saving, Production, Employment, and Investment

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