The Welfare Implications of Unobserved Heterogeneity

Sarantis Tsiaplias

Melbourne Institute Working Paper Series from Melbourne Institute of Applied Economic and Social Research, The University of Melbourne

Abstract: Conditions are derived for relating household well-being functions to household utility. In particular, an isomorphic relationship between the equivalent incomes stemming from subsistence-based utility functions and well-being functions is established. This allows estimates from standard models of well-being based on a CDF (eg. probit and logit models) to be given a formal welfare interpretation. New measures of the welfare distortion due to unobserved heterogeneity are also derived. An Australian household-level dataset is used as a case study for exploring the proposed measures of distortion. The results indicate that the failure to account for unobserved heterogeneity produces significant welfare distortions (primarily in the form of under-compensation). A unique welfare sensitivity curve is also estimated that indicates the presence of non-linearities that impair the typically monotonic relationship between household income, the household’s capacity to adjust its income and its marginal utility of consumption. The results are significant for better understanding the welfare implications of tax and transfer policies.

Keywords: Household expenditure; social welfare; consumption; heterogeneity; equivalence scales; income (search for similar items in EconPapers)
JEL-codes: C33 C35 D10 D12 D60 (search for similar items in EconPapers)
Pages: 43pp
Date: 2017-09
New Economics Papers: this item is included in nep-dcm and nep-upt
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: The Welfare Implications of Unobserved Heterogeneity (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:iae:iaewps:wp2017n21

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