Poverty and Welfare Measurement on the Basis of Prospect Theory

UNU-WIDER 2012 (109).

UNU-WIDER working paper.

Posted: 22 Aug 2014

See all articles by Jukka Pirttila

Jukka Pirttila

United Nations - World Institute for Development Economics Research (UNU/WIDER); Tampere University of Technology

Ravi Kanbur

Cornell University; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Milla Nyyssölä

Aalto University

Date Written: December 2012

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 behavioural 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 or she 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.

Keywords: prospect theory, poverty, inequality, welfare measurement, vulnerability

JEL Classification: I32, O12

Suggested Citation

Pirttila, Jukka and Kanbur, Ravi and Nyyssola, Milla, Poverty and Welfare Measurement on the Basis of Prospect Theory (December 2012). UNU-WIDER 2012 (109). . Available at SSRN: https://ssrn.com/abstract=2484362

Jukka Pirttila (Contact Author)

United Nations - World Institute for Development Economics Research (UNU/WIDER) ( email )

Katajanokanlaituri 6B
Helsinki, FIN-00160
Finland

Tampere University of Technology ( email )

P.O. 541, Korkeakoulunkatu 8 (Festia building)
Tampere, FI-33101
Finland

Ravi Kanbur

Cornell University ( email )

301-J Warren Hall
Ithaca, NY 14853
United States
607-255-7966 (Phone)
607-255-9984 (Fax)

HOME PAGE: http://www.kanbur.dyson.cornell.edu

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Milla Nyyssola

Aalto University ( email )

P.O. Box 21210
Helsinki, 00101
Finland

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