Specification and Estimation of Demand Systems with Limited Dependent Variables

Abstract

Econometric models for consumer demand systems with zero demand quantities are specified which consider observed demands as the result of optimal behavior. Our approach utilizes the concept of virtual prices to transform binding zero quantities into nonbinding quantities and to provide a rigorous justification for structural shifts in the observed (positive) demand equations across demand regimes. Switching conditions, which determine the occurrence probabilities of different demand regimes, are provided in terms of notional (latent) demand equations. This approach can estimate demand relationships derived from either direct or indirect utility functions. The econometric model is used to estimate a system of demand equations based on a household sample survey from Indonesia.