An exploration of Australian petrol demand: unobservable habits, irreversibility, and some updated estimates

We explore a methodological improvement to the standard dynamic demand model for petrol–a general model which allows for slowly evolving, unobservable habits. If this habit formation model is correct, then standard estimation techniques produce inconsistent estimates. We find price elasticities of -0.13 (short-run) and -0.20 (long-run). Importantly, standard techniques are misleading about the precision of elasticity estimates and the confidence interval around the long-run price elasticity is quite wide. We test for price irreversibility and find, in contrast to the U.S., almost no evidence that petrol responds differently to price increases and decreases. JEL CODES: C2, Q41