Variations in Risk: A Cause of Fluctuations in Demand?
1993 (English)Report (Other academic)
It is a common belief, both among economists and non-economists, that consumers' perception of the riskiness of their future real income is important for economic activity. Studies of the effects of risk on demand have generally assumed away transaction costs. This is critical assumption. Risk in conjunction with transaction costs will give rise to irreversibility effect that are likely to be quantatively important explanations for fluctuations in the demand for duarbles. I will show that the sensitivity for demand to variations in income risk is likely to be much higher for durables than for non-durables. Consumers' perception about the risk facing them presumable varies systematically over the business cycle. Irreversibility effects can then be an important business cycles mechanism. I will present a model in which agents know that the risk of income shocks varies stochastically as opposed to the standard procedure of doing comparative statistics. For durables that are renewed every five years, a temporary increase in the unemployment risk from one to ten percent per year causes the demand for duarbles to vanish for 3,5 months. The demand then stabilizes at a level 5% lower than before the increase in risk. Furthermore, I show that in contrast to the demand for non-durables, the fall in the demand for durables is larger the shorter the expected duration of the high risk period.
Place, publisher, year, edition, pages
Stockholm: IIES , 1993. , 44 p.
Seminar Paper / Institute for International Economic Studies, Stockholm University, ISSN 0347-8769 ; 532
IdentifiersURN: urn:nbn:se:su:diva-41851OAI: oai:DiVA.org:su-41851DiVA: diva2:337980