Economics Letters 61 (1998) 6771

Elasticities of beer demand revisited

Craig A. Gallet*, John A. List
Department of Economics, University of Central Florida, P.O. Box 161400, Orlando, FL 32816 -1400, USA
Received 15 October 1997; accepted 25 June 1998

Abstract
This paper uses U.S. aggregate beer consumption data from 19641992 to empirically estimate the elasticities of demand
for beer. However, rather than assuming the behavioral parameters are time invariant, we estimate a gradual switching
regression model that explicitly allows the elasticities to change over time. Results suggest that this more general model is
warranted, as findings illustrate the importance of variable dynamics when evaluating the efficacy of proposed policy
alternatives. 1998 Elsevier Science S.A. All rights reserved.
Keywords: Beer demand; Gradual switching regression
JEL classification: D10; C22

1. Introduction
Measuring elasticities of beer demand has become commonplace since the seminal work of
Niskanen (1962). This is not surprising given that beer constitutes one of the most heavily taxed
goods in U.S. history. Yet it is surprising that empirical studies have largely ignored the possibility
that these elasticities may be heterogeneous over time.1 Economic theory provides numerous reasons
why they may not be constant. For example, given the health risks of drinking became more apparent
in the 1970s and 1980s (see, e.g., Lee and Tremblay, 1992), in light of theoretical models developed
by Viscusi (1990) and Viscusi and Evans (1991), rational beer consumers should adjust their
sensitivity to changes in price and income.
Using aggregate beer consumption data for the U.S. over the 19641992 period, we relax the
restriction of response homogeneity over time and allow for a gradual adjustment of the estimated
elasticities. Consistent with recent developments in the beer industry, the results indicate that
elasticities began to adjust in 1973 and fully adjusted by 1983. In the remainder of this note, Section 2
describes the data and econometric techniques employed. Section 3 presents empirical results and
Section 4 provides concluding comments.
*Corresponding author: Tel.: 11 407 8233720; e-mail: craig.gallet@bus.ucf.edu
1
One exception is Horowitz and Horowitz (1965), who estimate the demand for beer across states using 13 regressions for
the period 19491961. They find that elasticities change over the sample period.
0165-1765 / 98 / $ see front matter 1998 Elsevier Science S.A. All rights reserved.
PII: S0165-1765( 98 )00146-3

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68

2. Empirical methodology and data description

The traditional approach to test for temporal change in equation structure is to include a dummy
variable and estimate a spline function.2 Such an approach assumes structural breaks are exogenously
determined and parameter adjustments are instantaneous. However, the habit formation model of
Pollack and Wales (1969), which suggests that consumers may respond slowly to new information,
implies a more relaxed estimation technique is warranted. Specifically, to allow for a gradual change
in the demand parameters over an endogenously determined time path, we estimate the U.S. demand
for beer using a gradual switching regression model (see, e.g., Ohtani and Katayama, 1985; Ohtani et
al., 1990), given by:

O ( b 1 F f )X 1
i

St 5 a 1

it

t;

t 5 1, 2,....., T

(1)

where St is the tth observation of the natural log of per capita (persons 18 and over) beer
consumption, Xit is the tth observation of the natural log of the ith regressor (which includes real price
of beer, real price of wine, and real per capita income),3 Ft is a gradual adjustment path which equals
0 before the adjustment and 1 after the adjustment is completed, bi and fi are unknown parameters of
2 4
interest, and the error term, t |N(0, s ). Appendix A contains a complete description of the data.
We allow the coefficients to gradually change (from bi to bi 1 fi ) by permitting Ft to vary along a
linear transition path, given by:

Ft 5 0 , for t , t 1* ,

(2)

5 a 0 1 a 1 t , for t *1 # t # t *2 ,
5 1 , for t . t 2* ,
where t *1 is the end-point of the first regime (estimated coefficients are bi ) and t *2 is the start-point of
the second regime (estimated coefficients become bi 1 fi ).5 Given values of t *1 and t *2 , it can be shown
that for t *1 #t#t *2 :

Ft 5 (t 2 t *1 ) /(t 2* 2 t 1* )

(3)

We use a method similar to Ohtani and Katayama (1985); Ohtani et al. (1990) to obtain the start
2

For example, Hamilton (1974); Bishop and Yoo (1985) use dummy variables to account for the effect of health information
releases on the demand for cigarettes.
3
We also included advertising in preliminary regressions. However, since it was found to be insignificant (similar to Lee and
Tremblay, 1992) and the nature of the regression did not appreciably change when advertising was included as a regressor,
we excluded it from the analysis.
4
Given the possibility of spatial variation in beer consumption, it would be interesting to estimate a fixed / random effects
regression model using state-level data (similar to Baltagi and Levin (1986) study of the demand for cigarettes). However,
given the lack of available data, we are unable to estimate such a model.
5
Note that the traditional dummy variable approach is nested in the gradual switching regression model. Hence, inherent in
our model is a test of the validity of the dummy-variable model.

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69

and end-points of Ft . Specifically, substituting Eq. (3) into Eq. (2), and the resulting expression into
Eq. (1), yields the estimated gradual switching regression model. Iterating across values of the start
and end-points, reported values of t *1 , t *2 , bi , and fi are those which optimize the objective function
used to estimate Eq. (1).6

3. Estimation results
Table 1 provides estimation results for the gradual switching regression model (columns 13) and
the homogeneous elasticity model (column 4). Estimates of the gradual switching coefficients (fi )
indicate an important behavioral change is evident in the data, as each elasticity estimate significantly
changed between 1973 and 1983. Also, comparison of parameter estimates in columns 13 with
column 4 illustrates the parameter variation between the two regression models. For example, the
estimated price elasticity in the homogeneous model is 22.17, whereas the gradual switching
regression model yields an estimated price elasticity of 21.72 between 19641973 and 0.26 (which is
insignificantly different from zero) after 1983. From a policy standpoint, this result has significant
implications. In the homogenous model, the estimated demand elasticity implies that increased
government taxation can greatly reduce beer consumption, but at the expense of lower tax revenue.
When accounting for a temporal change in consumer behavior, however, the results in the gradual
switching regression model imply the opposite for post-1983.
Other coefficient estimates also provide interesting insights. Parameter estimates on the log of real
Table 1
Estimated elasticities of beer demand a,b
Variables

Initial elasticities
( bi )

21.72*
(25.48)
Income
20.26
(21.25)
Wine price
0.66**
(2.64)
Durbin-Watson statistic52.37
R 2 50.965
t *1 51973, t 2* 51983
a 0 5 21.0, a 1 50.10
Beer price

Adjustments
(fi )

Post-83 elasticities
( bi 1 fi )

Homogeneous
(fi 50)

1.98*
(4.34)
20.58*
(25.35)
20.75**
(22.15)

0.26
(0.77)
20.83*
(23.51)
20.09
(20.36)

22.17*
(26.19)
20.48***
(21.75)
0.82*
(6.36)

, Dependent variable is the log of beer consumption.

, t statistics in parentheses.
*, Significant at the 1% level.
**, Significant at the 5% level.
***, Significant at the 10% level.
b

Since the price of beer is determined endogenously, Eq. (1) is estimated using two stage least squares. The set of
instruments (in natural logs) include real per capita income, real price of wine, real hourly beer production wage, real beer
industry material cost, real average state excise tax per barrel, number of breweries operating in the U.S., and a linear time
trend.

70

C. A. Gallet, J. A. List / Economics Letters 61 (1998) 67 71

per capita income from both models suggest that beer may be an inferior good. This finding is
consistent with results reported by Niskanen (1962); Comanor and Wilson (1974), amongst others,
but contradicts income elasticity estimates from Hogarty and Elzinga (1972). Furthermore, the
elasticity estimate for the price of wine in the homogeneous model implies that beer and wine were
substitute goods from 19641992, which is similar to the findings of Johnson and Oksanen (1977);
Niskanen (1962). The gradual switching regression model, however, suggests that beer and wine were
substitutes prior to 1973 (EBW 50.66), but unrelated after 1983 (EBW 5 20.09).
Numerous factors may explain why consumers behavioral parameters have changed over time.
One conjecture centers on the relationship between the valuation of health, addiction, and information.
In particular, the gradual release of information throughout the 1970s and 1980s concerning the health
risks of drinking may have led some consumers to reduce their intake of beer (see, for example, Lee
and Tremblay, 1992; Elzinga, 1990). This scenario would play itself out through the theoretical
models of Viscusi (1990); Viscusi and Evans (1991): individuals with a greater valuation of health
and less addictive nature reduced their consumption of beer, causing a re-distribution of demand
towards a less health conscious and more addictive segment. Hence, the gradual changes of price and
income elasticities between the 1970s and 1980s may be the result of a change in the distribution of
consumers.7 Finally, the finding that beer and wine gradually changed from substitute-goods to
unrelated commodities may be due to product differentiation in the beer industry (e.g., growth of lite
beers, premium beers, etc.).

4. Concluding remarks
Using demand for beer as an illustration, we employ a gradual switching regression model that
allows parameter heterogeneity over time. Beer demand elasticities were estimated for the U.S. market
over the 196492 period. The estimated elasticities illustrate the importance of variable dynamics
when evaluating the efficacy of proposed policy alternatives. For instance, estimates suggest that the
naive policymaker who sets tax rates ignorant of any temporal adjustment of price elasticity would
incorrectly estimate its effects over the 19641992 period.

Appendix A

Data Sources
Due to data limitations, we use annual data from 1964 to 1992. Beer consumption figures (in 31
gallon barrels) were obtained from various issues of Brewers Almanac (Beer Institute, various). Price
indices for beer and wine were collected from the Handbook of Labor Statistics (U.S. Department of
Labor, 1978) and various issues of the CPI Detailed Report (U.S. Department of Labor, various). Our
income variable consisted of observations on U.S. disposable income, which were taken from the
7

This result is consistent with findings that the heaviest drinkers are the least price responsive (Manning et al., 1995; Kenkel,
1996).

C. A. Gallet, J. A. List / Economics Letters 61 (1998) 67 71

71

Economic Report of the President (Council of Economic Advisors, 1995). To convert consumption
and income into per capita terms, we divided beer consumption and disposable income by the U.S.
population (of persons 18 and over), which was obtained from various issues of Current Population
Reports (U.S. Department of Commerce, various). In addition to the price of wine, per capita income,
and a linear time trend, instruments used to estimate beer demand consisted of the hourly beer
production wage, beer industry material cost, the average state excise tax per barrel, and the number
of breweries operating, all of which was collected from various issues of Brewers Almanac. Finally,
beer and wine prices, as well as per capita income, were deflated by the consumer price index; while
the hourly beer production wage, beer industry material cost, and average state excise tax per barrel
were deflated by the producer price index. Data on both deflators were taken from the Economic
Report of the President.

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