Nonlinear income effects in random utility models: revisiting the accuracy of the representative consumer approximation
AbstractThis article investigates the implications of nonlinear income effects in Random Utility Models (RUM) for measuring general equilibrium welfare impacts. A popular approach in applied welfare analysis is to approximate the expected compensating variation (cv) for an amenity change as the cv of a representative consumer whose indirect utility is given by the expected maximum utility. However, this approach can be misleading in the case of nonmarginal changes as it implies that changes in income do not affect the consumer's choice. In this case the true expected cv can be obtained via simulation. Empirical applications to recreational demand find that the bias from the representative approach is small. This article re-evaluates the accuracy of the representative consumer approximation in the context of measuring the general equilibrium welfare impacts of large environmental changes. Our findings suggest that, though the representative consumer approximation could lead to biased point estimates of the expected cv, this bias is overwhelmed by the size of the confidence intervals that result from the empirical estimation of household preferences.
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Bibliographic InfoArticle provided by Taylor & Francis Journals in its journal Applied Economics.
Volume (Year): 45 (2013)
Issue (Month): 1 (January)
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Web page: http://www.tandfonline.com/RAEC20
Other versions of this item:
- Constant Tra, 2009. "Nonlinear Income Effects in Random Utility Models: Revisiting the Accuracy of the Representative Consumer Approximation," Working Papers 0924, University of Nevada, Las Vegas , Department of Economics.
- Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects
- R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand
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