Econometrica: May 2016, Volume 84, Issue 3
Individual Heterogeneity and Average Welfare
Jerry A. Hausman, Whitney K. NeweyIndividual heterogeneity is an important source of variation in demand. Allowing for general heterogeneity is needed for correct welfare comparisons. We consider general heterogeneous demand where preferences and linear budget sets are statistically independent. Only the marginal distribution of demand for each price and income is identified from cross‐section data where only one price and income is observed for each individual. Thus, objects that depend on varying price and/or income for an individual are not generally identified, including average exact consumer surplus. We use bounds on income effects to derive relatively simple bounds on the average surplus, including for discrete/continuous choice. We also sketch an approach to bounding surplus that does not use income effect bounds. We apply the results to gasoline demand. We find tight bounds for average surplus in this application, but wider bounds for average deadweight loss.
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Supplement to "Individual Heterogeneity and Average Welfare"
In this supplementary material we give proofs of the results in the paper along with supplementary results deriving surplus bounds for discrete and continuous choice, some generalized conditions for the bounds under some knowledge of income effects, results on the potential size of income effects in the gasoline demand application, and additional details on the general bounds application. Assumptions, Lemmas, and Theorems specific to this supplemental material are listed with an "A" prefix, e.g. Assumption A1, Lemma A1, Theorem A1, etc..