Changes of household consumption behavior during the transition from centrally-planned to market-oriented economy

Date
1999
Authors
Huffman, Sonya
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Research Projects
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Economics
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Poland was the first country in Eastern Europe to re-establish a market economy. The new government introduced a number of economic reforms including elimination of the big state sector, which ended the state price control. As subsidies were withdrawn, incomes declined, prices rose rapidly and Polish living standards declined. Economic reforms also increased the availability of goods and changed the structure of consumption;This study focused on changes in household consumption behavior and welfare due to the transformation to a market economy in Poland 1987--92. The objectives of the study were to: (1) formulate a utility maximizing model of household's decisions in the presence of quantity rationing, (2) estimate a complete demand system, (3) determine whether households are better- or worse-off after the transformation of the economy;The following was accomplished. First, a consistent model of consumption decision making under rationing was developed. Second, to provide a bench mark the AIDS model was fitted to pre-reform quarterly data from the Polish Household Budget Survey, ignoring rationing. Some of the compensated own-price demand elasticities had "wrong signs" or implausible magnitudes. Next, virtual prices, the price at which the consumer would voluntarily choose the ration level of a good, were derived for food and housing to implement the pre-reform AIDS model with rationing. The estimates from the virtual AIDS gave plausible values for price and income elasticities. Third, the AIDS model was fitted to post-reform quarterly household survey data to obtain price and income elasticities. Finally, the parameter estimates were used to calculate cost of living indices for 1987--92. The study showed a roughly 70 percent decline in welfare for households over the transition with the most affected group being a family with three children;Assessing the effects of new policies requires careful analysis of household consumption in transition economies. Using virtual prices rather than actual prices for the rationed goods reduced greatly (by a factor of 4) the size of the welfare loss over the transition. Incorporating the effects of consumer rationing can greatly improve the accuracy of welfare policy formulation.

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