A Simple Nonadditive Preference Structure for Models of Household Behavior over Time

Abstract

Intertemporal separability is an almost universal assumption in empirical work on household behavior, but a good deal of recent work on consumption and labor supply suggests that it may not be tenable. The traditional weakening of this assumption is to allow for habit formation. I propose an alternative structure for intertemporal preferences that nests intertemporal additivity in a simple way and yields closed-form solutions for demand functions. This structure includes the neoclassical durables model as a special case. I derive a demand system that nests the almost ideal system as its time-separable counterpart. This model is estimated on U.K. aggregate time-series data for seven goods. Time separability is decisively rejected. Moreover, I find that ignoring temporal dependencies leads to considerable bias in the estimates of elasticities. Of the seven goods, durables display the strongest nonseparable effect; the estimated reactions are consistent with the neoclassical durables model.