Poverty and Welfare Measurement on the Basis of Prospect Theory

Markus Jantti, Ravi Kanbur, Milla Nyyssölä and Jukka Pirttilä

Review of Income and Wealth, 2014, vol. 60, issue 1, 182-205

Abstract: This paper examines the measurement of social welfare, poverty, and inequality, taking into account features that have been found to be important welfare determinants in behavioral economics. Most notably, we incorporate reference-dependence, loss aversion, and diminishing sensitivity—aspects emphasized in Prospect Theory—to social welfare measurement. We suggest a new notion of equivalent income, the income level with which the individual would be as well off, evaluated using a standard concave utility function, as he actually is, evaluated with a reference-dependent utility function. We examine the differences between standard poverty and inequality measures based on observed income and measures that are calculated based on equivalent income. These differences are illustrated using household-level panel data from Russia and Vietnam.

Date: 2014
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Working Paper: Poverty and Welfare Measurement on the Basis of Prospect Theory (2013)
Working Paper: Poverty and Welfare Measurement on the Basis of Prospect Theory (2013)
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