Measuring welfare using Hicksian demand curves
In this paper, Baqaee et al. develop a procedure for constructing money-metric representations of utility using repeated cross-sectional data. They trace out Hicksian, or compensated, demand curves through time by matching households whose incomes are equivalent in utility terms. Their approach is non-parametric, but relies on the assumption that preferences are the same in both the cross-section and the time-series dimensions and that all consumers face common prices.
We apply our method to household consumption survey data from the United Kingdom from 1974 to 2017. We find that the official annual inflation rate understates welfare-relevant inflation for the poorest households by around half a percentage point per year and overstates it for the richest households by around a quarter of a percentage point per year.
A New Method for Measuring Welfare with Income Effects using Cross-Sectional Data
Authors: David R. Baqaee, Ariel Burstein, Yasutaka Koike-Mori
From: UCLA
Measuring welfare using a correction term
Jaravel and Lashkari resolve the issue of non-homothetic preferences by introducing a correction term (which depends on the elasticity of the expenditure function with respect to utility) to correct the household-level chain-weighted index for non-homotheticity. Their approach measures welfare change while allowing for flexible dependence of the patterns of demand on income and other sources of observed heterogeneity without the need for functional form assumptions. The only additional data required for this approach is on a cross-section of product prices and quantities for consumers with heterogenous incomes, widely available through standard surveys of consumption expenditure.
Applying our approach to data from the United States, we find that the magnitude of the correction can be large due to the combination of fast growth and lower inflation for income-elastic products. Setting reference prices in 2019, we find that (i) aggregate real consumption per household in 1955 is underestimated by 11.5% by the uncorrected measure, and (ii) the correction reduces the annual growth rate from 1955 to 2019 by 18 basis points, which is larger than the well-known “expenditure switching bias” over the same time horizon.
Measuring Growth in Consumer Welfare with Income-Dependent Preferences
Authors: Xavier Jaravel, Danial Lashkari
From: London School of Economics, Boston College
