The Intuition Behind Income Effects of Price Changes in Discrete Choice Models, and a Simple Method for Measuring the Compensating Variation

Richard Batley () and Thijs Dekker ()
Additional contact information
Richard Batley: University of Leeds

Environmental & Resource Economics, 2019, vol. 74, issue 1, No 13, 337-366

Abstract: Abstract Small and Rosen’s (Econometrica 49(1):105–130, 1981) method for measuring consumer surplus using discrete choice models has been widely adopted in public policy analysis. For the case of a price change, the present paper elucidates five theoretical assumptions inherent within Small and Rosen’s measure, and employs indifference maps to demonstrate that this measure is only applicable to the context of a single discrete choice free of non-linear income effects. The paper argues that, where non-linear income effects are present, the aforementioned theoretical assumptions should be relaxed, and the consumption context revised from discrete choice to discrete–continuous demand. Furthermore, the paper proposes a simple analytical method for approximating the expected Hicksian compensating variation in the presence of non-linear income effects, and compares the empirical performance of this method against existing methods using data from Morey et al. (Am J Agric Econ 75(3):578–592, 1993). As well as offering a simple approximation, the proposed method yields insights on the potential range of the compensating variation depending on the extent of switching between choice alternatives, and on the attribution of the compensating variation to the relevant choice alternatives.

Keywords: Consumer surplus; Discrete choice models; Income effects; Discrete–continuous demand; Compensating variation (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
http://link.springer.com/10.1007/s10640-019-00321-2 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:enreec:v:74:y:2019:i:1:d:10.1007_s10640-019-00321-2

Ordering information: This journal article can be ordered from
http://www.springer. ... al/journal/10640/PS2

DOI: 10.1007/s10640-019-00321-2

Access Statistics for this article

Environmental & Resource Economics is currently edited by Ian J. Bateman

More articles in Environmental & Resource Economics from Springer, European Association of Environmental and Resource Economists Contact information at EDIRC.
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().