Nonparametric models in consumer behaviour

In its most basic form, the classical theory of consumer behaviour describes how a consumer allocates a given budget to a set of goods and services, while taking as given the prices of these goods and services. Although the most important implications of this theory have been known at least since Hicks (1939)’ Value and Capital, it has taken another fifteen years before the theory was brought in its entirety to real world data. This was done by Richard Stone (1954), who applied the Linear Expenditure System (LES) to British aggregate demand data. As shown by Geary (1950), the underlying preferences of the LES are of the Stone-Geary type. In other words, if one maximizes a direct utility function that presents Stone-Geary preferences subject to the consumer’s budget constraint, then one obtains the LES as the relation between the quantities purchased by the consumer, and her budget and the prices she is faced with. As is well-known, this system of Marshallian demand functions will satisfy all the theoretical implications of the maximization of rational preferences subject to a linear budget constraint. Firstly, it will satisfy adding-up, which implies that the sum of all the expenses on the different goods and services purchased by the consumer will be equal to the consumer’s budget. Secondly, the demand will be homogeneous of degree zero in prices and budget, which implies that if one multiplies all prices and the budget by, say, two, that the quantities purchased will remain unaffected (this implies that the consumer does not suffer from money illusion). Finally, the Slutsky matrix, that contains all the Hicksian or compensated price effects, will be symmetric and negative semidefinite. The latter implies, among others, that the consumer’s Hicksian or compensated demand of a given good can never increase following a price increase of that good, ceteris paribus. Stone’s work thus implies that for the first time a demand system was estimated that in principle could s(This abstract was borrowed from another version of this item.)