Nonlinear Income Effects in Random Utility Models: Revisiting the Accuracy of the Representative Consumer Approximation
The paper investigates the implications of nonlinear income effects in random utility models (RUM) for measuring non-marginal 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 non-marginal 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 paper 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.
|Date of creation:||Mar 2009|
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- Herriges, Joseph A. & Kling, Catherine L., 1999.
"Nonlinear Income Effects in Random Utility Models,"
Staff General Research Papers
1494, Iowa State University, Department of Economics.
- Holger Sieg & V. Kerry Smith & H. Spencer Banzhaf & Randy Walsh, .
"Estimating the General Equilibrium Benefits of Large Changes in Spatially Delineated Public Goods,"
GSIA Working Papers
2003-07, Carnegie Mellon University, Tepper School of Business.
- Holger Sieg & V. Kerry Smith & H. Spencer Banzhaf & Randy Walsh, 2004. "Estimating The General Equilibrium Benefits Of Large Changes In Spatially Delineated Public Goods," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(4), pages 1047-1077, November.
- Patrick Bayer & Robert McMillan & Kim Rueben, 2004. "An Equilibrium Model of Sorting in an Urban Housing Market," NBER Working Papers 10865, National Bureau of Economic Research, Inc.
- Kling, Catherine L. & Bockstael, Nancy & Michael, W., 1999.
"Estimating the Value of Water Quality Improvements in a Recreational Demand Framework,"
Staff General Research Papers
12334, Iowa State University, Department of Economics.
- Kling, Catherine L. & Bockstael, Nancy & Hanemann, W. Michael, 1987. "Estimating the Value of Water Quality Improvements in a Recreational Demand Framework," Staff General Research Papers 1594, Iowa State University, Department of Economics.
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