change in the price of the subsidized product. The second type of elasticity is cross-price elasticity of demand. The question addressed here is to what extent households will substitute the consumption of the subsidized product for other substitute products subject to an increase in the price of the subsidized product. For example, we try to assess the increase in household consumption of pasta when the price of rice increases.

The estimation of **demand elasticities** is the subject of a rich literature and is product specific. There are at least three types of settings we can consider. Under the first setting, the analyst can draw on the specific literature and borrow demand elasticities estimated elsewhere. For example, in certain countries and for certain products there exist a large literature on the estimation of demand elasticities which can then be used “off the shelves” for modeling. The demand elasticity for electricity in the US is one example. In this case, our manual will simply allow practitioners to input these values into the model.

Under the second setting, the analyst has longitudinal panel data and price shocks of the subsidized product along the period. This is the ideal scenario where demand elasticities can be estimated and then used in the simulation model. In reality, this setting is rare either because panel data are rarely available or because no significant change in prices has occurred.

More often the analyst has only one cross-section household survey, which is the reason why we have chosen to focus on this data setting. With one cross-section survey it is still possible to estimate demand elasticities but this requires price variability in the data. For example, we have representative data by region or district where the subsidized product price changes. Or, alternatively, we have a product with multiple prices across the nation according to quantities consumed (such as utilities prices). In these cases, we can exploit this variability to estimate demand elasticities based on the assumption of homogeneous behavior across households. We can also improve on this assumption by controlling for household characteristics. As compared to the first two options, this is a less appealing option but one that improves on ignoring behavioral effects altogether. Also, in multiple price settings, it is rare to have enough variation in prices to model the impact of the marginal price on consumption.

Cross-price elasticities are typically less important than own-price elasticity of demand to an extent that they are rarely modeled in subsidies reforms. That is because subsidized products tend to be essential items such basic food items or utilities, which are difficult to substitute or do not have natural substitutes. However, it is plausible that for some products and in some countries substitutes exist. For example, in some countries it is possible to partly substitute electricity consumption with gas consumption by using gas heaters as opposed to electricity heaters. The product analysis of Phase I should also have uncovered this type of issues and when substitution is likely to occur to an important extent it is advisable to estimate cross-price elasticities. In fact, given that cross-price elasticities will have an impact on demand elasticities, the two elasticities should be modeled in the same demand equation by controlling for the substitute product consumption.

**C – Impact analysis**

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