Public Economics Lectures Part 1: Introduction

Optimization Frictions: Examples
Agent pays adjustment cost k i to change consumption
Demand set optimally at initial price p 0
Let x(p) denote observed demand at price p
Define observed elasticity estimated from price increase as
̂ε = E log x 1 − E log x 0
log p 1 − log p 0
Observed elasticity confounds structural elasticity ε with adjustment
cost distribution:
̂ε = P(∆u i > k i )ε
Behavioral example: price misperception ˜p(p)
̂ε = ε E log ˜p(p 1) − E log ˜p(p 0 )
log p 1 − log p 0
Public Economics Lectures ()Part 5: Income Taxation and Labor Supply 186 / 217