Reconsidering the Economics of Demand Analysis with Kinked Budget Constraints

This paper has two objectives. First, we identify a problem with the ability of the discrete-continuous choice framework and conditional demand functions to fully describe consumer preferences in the presence of kinked budget constraints. Second, we propose and illustrate an alternative, preference-based method for estimating consumer responses to price changes under these conditions. This framework recognizes that commitments to commodities such as pools or outdoor landscaping influence how water consumption responds to price changes as part of the long-run consumption adjustments. With microdata on household choices, this approach could be used to design increasing block rate structures that recognize the differences in water consumption responses with these commitments.