David Pearce The University of Western Australia. Discussion Paper No December 1985

Size: px

Start display at page:

Download "David Pearce The University of Western Australia. Discussion Paper No December 1985"

Simon Wilkerson
6 years ago
Views:

1 ,, THE DEMAND FOR ALCOHOL IN NEW ZEALAND David Pearce The University of Western Australia Discussion Paper No December 1985 ISSN ISBN

2 DECEMBER 1985 THE DEMAND FOR ALCOHOL IN NEW ZEALAND by * David Pearce Department of Economics The University of Western Australia * This paper is based on my Honours Dissertation at The University of Western Australia. I would like to thank Professor Kenneth Clements for his guidance and advice and Peter Goldschmidt and Kal Stening for their computing assistance.

3 CONTENTS 1. INTRODUCTION 1 Page 2. PREVIOUS STUDIES THE DATA THE MODEL 8 5. EMPIRICAL RESULTS AN APPLICATION: THE WELFARE COST OF ALCOHOL TAXES 15 REFERENCES ':'

4 1 1. INTRODUCTION This paper is concerned with estimating demand equations for alcohol in New Zealand. To this end we follow the approach taken by Clements and Johnson (1983) and Selvanathan (1985) in applying Theil's (1980) differential approach to consumption theory to the demand for alcoholic beverages {beer, wine and spirits). Alcohol demand studies are important when considering various aspects of public policy towards alcohol. One such aspect is that of the taxation of alcoholic beverages. Taxation of alcohol is usually an important source of government revenue. Alcohol demand studies provide quantitative guidance as to the possibility of increasing revenue by increasing taxation as well as giving information about the welfare cost of taxes that are imposed. We proceed by briefly reviewing in Section 2 some previous studies on alcohol demand. In Section 3 we present the New Zealand alcohol data and in Section 4 we set out the demand model. In section 5 we use the data to estimate the demand equations. Finally, in Section 6 we give an application of these estimates, the measurement of the welfare cost of alcohol taxes in New Zealand. 2. PREVIOUS STUDIES We now present a bri~f review of previous research. Clements and Johnson (1983), using the differential approach to demand theory, obtain compensated own-price elasticities of -.4, -.4 and -.7 for beer, wine and spirits, respectively. These results can be contrasted with those

5 '. 2 of a recent study carried out by.the.economic and Budget Review Committee, the Report on the Wine Industry in Victoria. (We shall refer to this as the Victorian wine report); This report found the compensated ownprice elasticities to be -1.2, -1.3 and -1.3 for beer, wine and spirits. These two sets of estimates have considerably different implications and reflect differences in both the data used and methodology. Clements and Johnson use Australia-wide annual data while the Victorian wine report uses bi-monthly Victorian data obtained from a private source. Probably the most important source of difference, however, is that of the theoretical model used in the studies. The Victorian wine report uses the linear expenditure system (LES) to estimate the demand equations. The LES is based upon a utility function that exhibits preference independence. Under preference independence the marginal utility of good i depends only on the consumption of good i, so that there is no interaction between goods in the utility function. This is a very strong restriction to place on finely distinguished goods such as beer, wine and spirits. As such a restriction is not intuitively appealing, it is unfortunate that the hypothesis of preference independence was not tested in the Victorian report. It is also to be noted that, according to this report, the demand for each beverage is price elastic, a result which is somewhat difficult to reconcile with the::habitual nature of alcohol. Selvanathan (1985), using the differential approach to demand theory, obtained for the United Kingdom compensated own-price elasticities of -.2, -.5, and -.9 for beer, wine and spirits. It is noteworthy that these estimates are not too far away from those obtained by Clements and Johnson.

6 . ' 3 Turning to New Zealand, a commissioned study for the Alcoholic Liquor Advisory Council (Easton and Kay, 1982) obtained, using a doublelog model, compensated own-price elasticities of -.4, -1.0 and -1.0 for beer, wine and spirits. Beer demand is price inelastic, which agrees with Clements and Johnson's findings, while wine and spirits have unitary elasticities. 3. THE DATA The alcohol quantity data used in this study were obtained from the Alcoholic Liquor Advisory Council (1985), whose estimates originated from the New Zealand Department of Statistics. Alcohol consumption is estimated on the basis of production for sale, i.e. home production plus imports and minus exports. The data are annual for the period 1965 to 1982; data for the years 1983 and 1984 are not used as the Department of Statistics changed the.basis for measuring alcohol consumption in these years. Price data from 1974 were obtained from the Department of Statistics, 1974 being the year jn which the official price series for alcoholic beverages commenced. Prior to 1974, prices were obtained from St. John (1981). Table 1 presents the quantity and price log-changes, Dqit =log qit - log qi,t-l and Dpit =log pit - log Pi,t-l' where pit and q. are the price and per capita quantity consumed of beverage i (i = beer, it wine and spirits) in year t. As can be seen, the average growth in per capita consumption was.9, 9.3 and 3.1 percent per annum for beer, wine and spirits, respectively.

7 4 TABLE 1 ALCOHOL QUANTITY AND PRICE LOG-CHANGES: NEW ZEALAND, Year Beer Wine Spirits Quantity Price Quantity Price Quantity Price o.ooo Mean The quantities are expressed in per capita terms. The year 1966, for example, refers to the transition from 1965 to All entries are to be divided by 100.

8 5 Let there be n goods, with the alcoholic beverages the first three. We write M = E~=l budget share and WA Then,w./W for i = 1 A piqi for total expenditure, wi = piqi/m for the ith '\ = Li;l wi for the budget share of alcohol as a whole. 1, 2, 3 is the share of beverage i in total alcohol expenditure, which is known as the conditional (i.e. within alcohol) budget share. years t-1 and t, Table 2 presents the arithmetic averages of w. and W over the 1 A as well as wit/wat" As can be seen, on average the share of beer in total expenditure is 4.0 percent, that of wine is.8 percent and that of spirits is 1.6 percent. The share of total alcohol (WA) at means is = 6.4 percent. Table 2 shows that, on average, beer accounts for 63 percent of total expenditure on alcohol, wine 12 percent and spirits 25 percent. The conditional budget shares of beer and spirits declined over the period, while that of wine increased sharply. we summarize the above information in the form of Divisia volume and price indexes for alcoholic beverages: = 3 E i=l w At = These indexes are presented 'n columns 1 and 2 of Table 3. Table 3 also presents, in column 3, the Divisia price-quantity correlation coefficient, = '

9 TABLE 2 ARITHMETIC AVERAGES OF UNCONDITIONAL AND CONDITIONAL BUDGET SHARES FOR ALCOHOL:. NEW ZEALAND, Year Unconditional Conditional Beer Wine Spirits Total alcohol Beer Wine Spirits - wl w2 w3 WA w/wa w/wa w3/wa o O' l l l , Mean The year 1966, for example, refers to the arithmetic average of the budget shares in the years 1965 and All entries are to be divided by 100.

10 7 TABLE 3 DIVISIA MOMENTS OF ALCOHOL CONSUMPTION: NEW ZEALAND, Year Volume index Price index Price-quantity correlation DQA x 100 DP x 100 A (1) (2) PA (3) Mean o The year 1966, for example, refers to the transition from 1965 to 1966.

11 8 where = 3 E i=l w At is the Divisia price-quantity covariance; and 3 E i=l w At ' = are the Divisia price and quantity variances. The correlation is negative in 11 cases out of 17 with an average of This reflects the tendency for drinkers to move away from those beverages having above-average price increases. 4. THE MODEL we block the n goods into two groups, alcoholic beverages, denoted by SA, and everything else, SE. We take these two groups to be blockindependent in the consumer's utility function. This means that the marginal utility of beverage i depends on the quantities consumed of the alcoholic beverages, but not the consumption of the non-alcohol goods. Under block independence the consumer proceeds in two steps, first allocating total expenditure between SA and SE; and then, given total alcohol expenditure, allocatiug that to beer, wine and spirits. consequently, the block independence assumption means that we can analyse the demand for three beverages without reference to the prices of the other goods.

12 9 The conditional demand equation for beverage i under block independence can be written as (Theil, 1980) (1) w.d(log q.) l. l. = S!WAd(log Q ) + l. A 3 A E rr.. d (log p.) j=l l.j J where 8~ l. is the conditional marginal share which gives the proportion of an additional dollar of spending on alcohol devoted to beverage i; 3 A i=l 1 1 d(log Q ) = E. w.d(log q.) is the Divisia volume index in infinitesimal change f arm; an d 1r, A. is the ( 1, J ')th con d' l. tiona ' 1 S 1 uts k y coe ff. 1c1ent. w h' ic h l.j measures the effect of a change in the price of beverage j on the demand for i, total expenditure on alcohol and the other prices remaining constant. The conditional Slutsky coefficients satisfy demand homogeneity, 3 A (2) E 'IT = 0 l.j j=l i = 1, 2, 3 and Slutsky symmetry, (3) A A 1.J Jl. 'IT = 'IT.. i,j = 1, 2, 3. To apply (1) to finite-change data we make four adjustments. First, we specify the conditional marginal shares to take the Working (1943) form, i.e. Si = Si + wit/wat where Si is a constant satisfying 3 Ei=l Si = O. Second, we replace wi and WA with their arithmetic averages, - - wit and WAt" Third, we replace d(log x) with Dxt =log xt - log xt-l' the log-change in x. Finally, we take the rr~.'s 1.J to be constants. The resulting estimating equations, with intercepts and disturbances added, are (4) = 3 A E 'IT,.Dp.t j=l 1.J J i = 1, 2, 3.

13 10 Th.e "it's are serially independent, ~o~allydi~tributed disturbances with zero means and a cons~ant contemporaneous covariance matrix. The constant term )... allows for trend-like changes in tastes etc. The implied 1 conditional income elasticities are 1 + [ ai ] Thus, a beverage with wi/wat. a positive ai is a luxury while one with a negative ai is a necessity. The A - conditional price elasticities are Tiij/wit" 5. EMPIRICAL RESULTS We use the New Zealand alcohol data to estimate (4) by maximum likelihood under the assumption that DQAt and Dpit are predetermined variables. Throughout we use Wymer's (1977) program RESIMUL (see also Goldschmidt, 1983). The estimates are given in Table 4. As can be seen, the constant terms indicate a significant autonomous trend into wine and out of the other two beverages. The value of the likelihood ratio test statistic for testing the homogeneity and symmetry restrictions is This is below the critical value of x 2 (3) at the 5 percent level of Thus we are unable to reject homogeneity and symmetry. The income coefficients a. and the Slutsky coefficients are not estimated precisely. 1 In an attempt to improve the precision of the estimates of the Slutsky coefficients, we shall experiment with block structures within alcohol. The obvious starting point is the most stringent, that of preference independence within alcohol. In this case, the conditional Slutsky coefficients take the form (Theil, 1980) (5) A TI., = y8~ (Ii,. - 8!) J.] 1 1] J i,j = 1, 2, 3,

14 11 TABLE 4 CONDITIONAL DEMAND EQUATIONS FOR ALCOHOLIC BEVERAGES: NEW ZEALAND, a A E 1f Dp.t + Eit j=l J.] J (Asymptotic standard errors in parentheses) Beverage Constant Conditional Conditional Slutsky coefficients income coefficient A A A A. J. Tril Tri2 1f i3 x 1000 a. x 100 x 100 x 100 J. Beer (. 285) (.134) (. 434) (.182) (. 446) Wine (.145) (. 069) (.152) (. 211) Spirits (. 326) (.155) (. 531) x2 = 5.68 with 3 degrees of freedom

15 12 where y is a negative constant independent of i and j and Ii.. is the '-J Kronecker delta. It can be shown that y/wa is interpreted as the ownprice elasticity of demand for alcohol as a group. We shall evaluate (5) at sample means so that we replace el with Si + the mean of wit/wat. The estimation results under preference independence are given in Table 5. The imposition of preference independence has the desired effect of reducing substantially the standard errors.of most of the Slutsky coefficients. It is to be noted that most of the point estimates of the Slutsky coefficients given in Table 5 agree rather well with those of Table 4 where preference independence is not imposed. This suggests that the data are compatible with the hypothesis of preference independence. This is indeed the case as the likelihood ratio statistic is 5.95, well below the critical value of X 2 (5) at the 5 percent level of Thus, we are unable to reject preference independence. The point estimates of the S. indicate that, within alcohol, wine ]_ and spirits are luxuries while beer is a necessity~ Note, however, that these are not significant which implies that the conditional income elasticities are insignificantly different from unity. The estimate of y is significant and it implies an own-price elasticity of total alcohol of -.023/.064 = -.4, where.064 is the mean of WA. Table 6 contains the conditional income and price elasticities implied by the estimates given in Table 5. We see that, at sample means, the income elasticities are.9, 1.1 and 1.3 for beer, wine and spirits respectively and the own-price elasticities are -.2, -.4 and -.3. As is to be expected, there is not a great deal of substitutability between the beverages.

16 13 TABLE 5 CONDITIONAL DEMAND EQUATIONS FOR ALCOHOLIC BEVERAGES UNDER PREFERENCE INDEPENDENCE: NEW ZEALAND, = a A E rr.. Dp. j=l l.j Jt + E:i't (Asymptotic standard errors in parentheses) Beverage Constant Conditional Conditional Slutsky coefficients income coefficient A A A 1'. 1f. ]. 1f il J.0 'ITi3 x 1000 ai x 100 x 100 x 100 Beer (. 281) (.122) (. 277) (. 095) (. 232) Wine (.138) (. 062) (.133) (. 061) Spirits (. 320) (.124) (. 271) x' = 5.95 with 5 degrees of y = (.0112) freedom

17 14 TABLE 6 CONDITIONAL DEMAND ELASTICITIES FOR ALCOHOLIC BEVERAGES: NEW ZEALAND, Beverage Conditional income elasticity ai 1 +-~-- ;:;it/wat Conditional price elasticities A /w.t A /w.t Beer Wine Spirits Beer Wine Spirits Sample means Beer Wine Spirits Based on Table 5 estimates and Table 2 data.

18 15 6. AN APPLICATION: THE WELFARE COST OF ALCOHOL TAXES In this section we use the estimates to calculate the welfare cost of alcohol taxes imposed in New Zealand in Table 7 presents the taxation revenue and tax rates for 1981 (from Easton and Kay, 1982); The welfare cost is measured as the reduction in consumer surplus not offset by government revenue from the taxes and can be expressed as follows (Harberger, 1964) 3 3 W = -! E E T. S.. T. i=l j=l l. l.j J where T. is the tax per unit of i l. s.. = aq./ap. with real income constant. l.] l. J (measured in terms of dollars) and This cost can be expressed as a fraction of total expenditure M as (Clements and Johnson, 1983) (6) w M = -t 3 E i=l 3 ti A E lt rr.. j=l + i l.] t. _]_ l+t. J 3!y(l-8 ) E A. 1 l.= 3 t. E ' 8' j=l l+ti i j t. _]_ l+t. J where t. is the tax rate on i and 8 a group. l. A is the marginal share of alcohol as To evaluate (6) we use BA=.0327, the value estimated by Pearce A (1985); the estiffiates of y and 1T given in Table 5 and 8' = S 1 + 1], i mean of ;.t/w, with the S. 's from Table 5. Table 8. l. At l. The results are given in For 1981 the welfare cost of alcohol taxes is $5.05 per capita. This is 1.4 percent of expenditure on alcoholic beverages and 5.3 percent of government revenue from alcohol taxes. All in all, the average cost of tax revenue from alcohol of 5 percent seems. to be quite modest.

19 16 TABLE 7 ALCOHOL TAXES: NEW ZEALAND, 1981 Beverage Tax revenue (dollars per capita p.a.) Tax rate (percentage of pre-tax price ) Beer Wine Spirits Total alcohol TABLE 8 WELFARE COST OF ALCOHOL TAXES: NEW ZEALAND, 1981 Cost as a percentage of total consumption expenditure Cost in dollars per capita p.a. Cost as a percentage of alcohol expenditure Cost as a percentage of taxation revenue from alcohol

20 17 REFERENCES Alcoholic Liquor Advisory Council (1985). New Zealand Alcohol Consumption Statistics. Wellington, New Zealand. Clements, K.W. and L.W. Johnson (1983). "The Demand for Beer, Wine and Spirits: A System-wide Analysis". Journal of Business 56, Reprinted in T.J. Coyne (ed.) Readings in Managerial Economics, 4th edition, 1985, Business Publications Inc., Plano, Texas, pp Easton, B.H. and L.B. Kay (1982). The Impact of Taxation on Alcohol Consumption. Alcoholic Liquor Advisory Council, Wellington, New Zealand. Economic and Budget Review Committee (1985). Report on the Wine Industry in Victoria. Economic and Budget Review Committee, Melbourne. Goldschmidt, P.S. (1983). "Running the TRANSF and RESIMUL Programs at The University of Western Australia". Mimeographed manuscript, Department of Economics, The University of Western Australia. Harberger, A.C. (1964). "Ti!Xation, Resource Allocation and Welfare". In The Role of Direct and Indirect Taxes in the Federal Revenue System, edited by J. Due, Princeton: Princeton University Press, for the NEER and the Brookings Institution. Reprinted in A.C. Harberger (1974), Taxation and Welfare, Chicago; University of Chicago Press.

21 18 Pearce, D. (1985). The Demand for Alcohol in New Zealand. B.Ec. Honours Dissertation, Department of Economics, The University of Western Australia. Selvanathan, E.A. (1985). "The Demand for Alcohol in the U.K.: An Econometric Study". The University of Western Australia, Department of Economics Discussion Paper No St. John, S. (1981). "The Price of Alcohol ". Paper prepared for the Alcohol Research Unit, Aucklan.d University. Theil, H. (1980). The System-wide Approach to Microeconomics, Chicago: The University of Chicago Press. Working, H. (1943). "Statistical Laws of Family Expenditure". Journal of the American Statistical Association 38: Wymer, C.R. (1977). "Computer Programs: RESIMUL Manual". Mimeographed Manuscript, International Monetary Fund, Washington.

Abstract. Alcohol and Food Consumption, 110 Countries in 2005

Abstract. Alcohol and Food Consumption, 110 Countries in 2005 Ithaca 2018 Abstract Submission Title UNDERSTANDING ALCOHOL CONSUMPTION ACROSS COUNTRIES I want to submit an abstract for: Conference Presentation Corresponding Author Ken Clements E-Mail ken.clements@uwa.edu.au