Back to the future? Habits and rational addiction in UK tobacco and alcohol demand.

Abstract

This paper develops a dynamic modeling approach for the Almost Ideal Demand System, which is consistent with the rational addiction theory. The forward-looking hypothesis is combined with that of convex adjustment costs in the presence of non-stationary cointegrated variables. Estimation is based on a two-step strategy based on cointegration and GMM techniques. Results on UK tobacco and alcohol demand support the adopted specifications and highlight the degree of complementarity between addictive goods.