Costs, Uncertainty and Durable Adjustments – Finnish Cross-Sectional Evidence f rom Automobile Purchases

Based on the Cobb-Douglas preferences and standard (S,s) model this study extends the previous theoretical frameworks by deriving explicitly the optimal consumption rule for durables. The model states that an agent has a desire to keep a fraction of his wealth to be invested in a durable. Because of the depreciation of the durable together with stochastic movements in prices and agent’s wealth, the actual fraction deviates from that of the target. Including the possibility of uncertainty, the model shows that it is optimal for the agent to allow an inaction (S,s) band around the target level of durable to avoid irreversible investment costs, and not to adjust until the critical band trigger is reached. The implications of the model the width of the inaction (S,s) band is positively related to an increase in uncertainty, while a higher depreciation rate leads to more frequent adjustment were tested using four Household Budget Surveys from Finland. The results on automobile purchases did not reject the (S,s) model. Higher income uncertainty widens the inaction band and decreases the probability of adjustment, while an increase in repair costs increases the probability of adjustment.