The Dependence of Private Consumer Demand on Public Consumption Expenditures: Theory and Evidence

Abstract

Two different approaches are used to study how the structure of public consumption affects the allocation of consumer expenditure. The first assumes that public expenditures condition consumer preferences and introduces them as additional explanatory variables to the Linear Expenditure System by means of linear translating. Assuming that consumers are constrained in consuming publicly provided goods, the second uses the Almost Ideal Demand System to model preferences as nonseparable between privately and publicly provided goods. The resulting demand functions depend on total private expenditure, relative prices, and the quantities of public provision. Testing the predictions with U.K. data establishes the importance of public consumption expenditures in determining private consumer demand.