# We consider each of these areas<sup>below.</sup>

## _Substitution in consumption and_<sup>_production_</sup>

To allow for substitution in consumption<sup>one needs to obtain at leastincome and own-</sup> price (and preferably also cross-price)<sup>elasticitiesof demand.The easiest way to obtain</sup> these is to draw them from existing<sup>studies of the country of interest.Alternatively,one</sup> could attempt to estimate commodity<sup>demand equationsusing one of the standard</sup> demand systems (LES, AIDS,<sup>AIDADSetc).Ideally timeseriesdata on demandsfor</sup> various goods, prices and incomes<sup>is neededto ensurea reasonableamountof variation in</sup> prices. Alternatively, one may<sup>useDeaton's method of exploitingspatial variationin unit</sup> prices to estimate own and cross-price<sup>elasticities(see Deatonand Grimard,1992;</sup> Deaton, 1997). Nicita (2002) provides<sup>an exampleof the applicationof this approach to</sup> Mexico.

Estimating these elasticities provides<sup>a partialequilibriumway of assessing the</sup> magnitude of "second round" consumption<sup>effects of price reforms. However,estimating</sup> such elasticities is not a trivial matter,<sup>especially if only cross-sectionaldataare available.</sup> Moreover, it is not clear that incorporating<sup>the ability to substitutein consumption is that</sup> important. When prices change<sup>simultaneouslyfor a large number of commodities,</sup> incorporating the ability to substitute<sup>in consumptionappears in many practical</sup> circumstances to make little difference<sup>to the overall welfareeffects.This suggeststhat it</sup> may only be worth the additional<sup>effort of estimating such elasticitiesif one has a</sup> particular reason for believing<sup>that consumption substitutioneffectsare likely tobe</sup> important. On the other hand, if reasonable<sup>consumption elasticitiesare alreadyreadily</sup> available from other studies,<sup>their incorporationwithin the above frameworkis</sup> straightforward (see below) and<sup>there is no reasonfor not doingso.</sup> To allow for substitution in production<sup>one could attempt to estimateoutput supply or</sup> factor demand equations.. As with<sup>estimatingconsumptiondemand systems,this requires</sup> one to make assumptions about<sup>the functional formof the output supply/factordemand</sup> functions, and there must be a reasonable<sup>amount of variation in pricesin the data.Again</sup> the easiest approach is to draw the<sup>resultingsupply elasticitiesfrom existing studies.If</sup> these are not available then time series<sup>data is needed on outputs,prices and factor</sup> demands. Alternatively, one may<sup>attempttoestimateelasticitiesby combiningcross-</sup> sectional and time-series data (see<sup>Mundlak(1963)),but estimatingsuch elasticities</sup> solely from cross-sectional data<sup>is particularly difficultfor agriculturalproduction</sup> because natural conditions also<sup>cause largevariationsin supply.Furthermore,estimates</sup> of supply functions tend to assume<sup>smoothsubstitutability between the production of</sup> different commodities whereas<sup>in factthe majorwelfarechangesmay occur when</sup> markets are created or destroyed<sup>as a result of reforms. Such discontinuitiesare not</sup> generally captured in traditional<sup>supply systems.</sup> 13