Estimating demand systems: A brief survey

Abstract

The theory of consumer demand is the oldest and one of the most fruitful research areas in economics. Theoretically, it is concerned with allocation problems that are the foundation of microeconomics, that is, the optimal allocation of given means over various alternatives. Besides consumer behaviour, the allocation models are explored to solve problems in other topics of economic theory, like production, trade, and agriculture. The understanding of consumer demand analysis surely helps one build up the knowledge of the methodology of economic studies. Empirically, demand analysis provides policy-makers with important reference for their decisions on welfare issues such as poverty and inequality measurement. The tax reform in Europe and US is the drive for the new round of great interest in this area because demand analysis can roughly depict the welfare consequences by its indices. A number of books have done comprehensive surveys of applied demand analysis, for example Bewley (1986), Deaton and Muelbauer (1980), and Pollak and Wales (1992). Numerous articles also have been published on this topic. However, the literature is often too academic for nonspecialists to comprehend. Therefore, this paper focuses the attention on understanding the evolution of the applied demand analysis and the methodology required. In reviewing relevant literature, this paper aims to give readers an overall picture of this area. Section 2 starts from the origin of demand and then discusses the properties of demand functions. After this, it goes to the choice of functional forms, which is the actual construction of demand systems. The last part of this section introduces some common specifications of demand systems and their merits and weakness. Section 3 discusses how to compare different systems on the basis of their performance. Section 4 concludes the whole paper.