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Foundations of Welfare Economics and Product Market Applications

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  • Daniel McFadden

Abstract

A common problem in applied economics is to determine the impact on consumers of changes in prices and attributes of marketed products as a consequence of policy changes. Examples are prospective regulation of product safety and reliability, or retrospective compensation for harm from defective products or misrepresentation of product features. This paper reexamines the foundations of welfare analysis for these applications. We consider discrete product choice, and develop practical formulas that apply when discrete product demands are characterized by mixed multinomial logit models and policy changes affect hedonic attributes of products in addition to price. We show that for applications that are retrospective, or are prospective but compensating transfers are hypothetical rather than fulfilled, a Market Compensating Equivalent measure that updates Marshallian consumer surplus is more appropriate than Hicksian compensating or equivalent variations. We identify the welfare questions that can be answered in the presence of partial observability on the preferences of individual consumers. We examine the welfare calculus when the experienced-utility of consumers differs from the decision-utility that determines market demands, as the result of resolution of contingencies regarding attributes of products and interactions with consumer needs, or as the result of inconsistencies in tastes and incomplete optimizing behavior. We conclude with an illustrative application that calculates the welfare impacts of unauthorized sharing of consumer information by video streaming services.

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  • Daniel McFadden, 2017. "Foundations of Welfare Economics and Product Market Applications," NBER Working Papers 23535, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:23535
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    References listed on IDEAS

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    Cited by:

    1. Donald S. Kenkel & Sida Peng & Michael F. Pesko & Hua Wang, 2020. "Mostly harmless regulation? Electronic cigarettes, public policy, and consumer welfare," Health Economics, John Wiley & Sons, Ltd., vol. 29(11), pages 1364-1377, November.
    2. De La Maza, Cristóbal & Davis, Alex & Azevedo, Inês, 2021. "Welfare analysis of the ecological impacts of electricity production in Chile using the sparse multinomial logit model," Ecological Economics, Elsevier, vol. 184(C).

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    More about this item

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D60 - Microeconomics - - Welfare Economics - - - General
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • K13 - Law and Economics - - Basic Areas of Law - - - Tort Law and Product Liability; Forensic Economics
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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