Revealed Preference Heterogeneity (Job Market Paper)

Evaluating the merits of alternative tax and incomes policies often requires knowledge of their impact on consumer demand and welfare. Attempts to quantify these impacts are complicated; aggregate demand responses depend on the population distribution of preferences for commodities, yet consumer preferences go unobserved and economic theory places few restrictions on their form and distribution. These complications become especially acute when individuals are making choices over many goods because transitivity must be imposed for rationality of demand predictions and simultaneity must be addressed. In this paper, I develop a revealed preference methodology to bound demand responses and welfare effects in the presence of unobserved preference heterogeneity for many-good demand systems. I first derive the revealed preference restrictions that are implied by a simple random utility model, and then develop these inequalities into a linear programming problem that allows for the recovery of the model’s underlying structural functions. I show how the feasible set of this linear programme can be used to construct virtual prices that enable one to conduct positive and normative analysis for heterogeneous agents. The utility of this approach is demonstrated through an application to household scanner data in which multidimensional preference parameters are recovered, and individual demands and the distribution of demands are predicted for hypothesised price changes. ∗I would like to thank Richard Blundell, Steve Bond, Martin Browning, Laurens Cherchye, Ian Crawford, Bram De Rock, Stefan Hoderlein, Jeremias Prassl, Collin Raymond, Frederick Vermeulen and seminar participants at cemmap, Institute for Fiscal Studies and Oxford for useful discussion and comments. I gratefully acknowledge financial support from the European Research Council (ERC) under ERC-2009-AdG grant agreement number 429529. Data supplied by TNS UK Ltd. The use of TNS UK Ltd. data in this work does not imply the endorsement of TNS UK Ltd. in relation to the interpretation or analysis of the data. All errors and omissions are my own. Contact Information: Department of Economics, University of Oxford and Institute for Fiscal Studies, London. Email: [email protected]