Testing an IV method for reducing quality bias in demand systems estimations

ABSTRACT

Price elasticities of substitution estimated with demand systems and household survey data might suffer of an endogeneity bias due to measurement errors and unobserved quality substitution. The paper compares Deaton’s and Cox and Wohlgenant’s approaches commonly used to reduce this bias with a method based on instrumental variables. The test is conducted on selected food and beverage goods inVietnam. Price elasticities not corrected for quality substitution obtained with standard market prices are used as a benchmark. Results show that the instrumental variable method significantly reduces the endogeneity bias and performs better than the compared methods. Moreover, it is based on fewer assumptions and controls for measurement errors. Its main limitations are that it still implicitly assumes that price changes have no impact on quality and that it relies on identifying suitable instruments.

KEYWORDS:

• Price elasticity
• quality substitution
• QUAIDS
• instrumental variable
• endogeneity

JEL CLASSIFICATION:

• C30
• D10
• O12

Acknowledgement

We would like to thank Jacques Morriset, Quang Hong Doan, Andrew Burns and Doerte Doemeland for their support and valuable comments during the preparation of this paper. We are also grateful to the National Center for Socio-economic Information and Forecast for supplying some of the data used in the study. Financial support from the Government of Australia, through the Australia – World Bank Group Strategic Partnership in Vietnam Phase 2 (ABP2) is greatly appreciated

Disclosure statement

No potential conflict of interest was reported by the author(s).

Disclaimer

The findings, interpretations and conclusions expressed herein are those of the authors and do not necessarily reflect the view of the World Bank Group, its Board of Directors or the governments they represent.

Notes

¹ Consumption behaviour in Vietnam may vary between regions, urban/rural areas, and income groups. See Bairagi et al. (2020) for different price elasticities between urban and rural households in Vietnam. Because the main objective of this paper is methodological, we use the full sample of the 2016 VHLSS providing average elasticities for all types of households.