Homothetic Efficiency

32 Pages Posted: 7 Feb 2015

See all articles by Jan Heufer

Jan Heufer

Erasmus University Rotterdam (EUR) - Department of Applied Economics; Tinbergen Institute

Per Hjertstrand

Research Institute of Industrial Economics (IFN)

Date Written: July 6, 2014

Abstract

This article provides a robust non-parametric approach to demand analysis based on a concept called homothetic efficiency. Homotheticity is a useful restriction or assumption but data rarely satisfy testable conditions. To overcome this problem, this article provides a way to estimate homothetic efficiency of consumption choices by consumers. The basic efficiency index suggested is similar to Afriat’s (1972) efficiency index and Varian’s (1993) violation index. It generalises Heufer’s (2013b) two-dimensional concept to arbitrary dimensions and is motivated by a form of rationalisation similar to the one proposed by Halevy et al. (2012). The method allows to construct scalar factors which can be used to construct revealed preferred and worse sets. The approach also provides considerably more discriminatory power against irrational behaviour than standard utility maximisation. An application to experimental and household expenditure data illustrates how the method allows to recover preferences and increase test power.

Keywords: Demand theory; efficiency; experimental economics; homotheticity; non-parametric analysis; revealed preference; utility maximisation

JEL Classification: C14, D11, D12

Suggested Citation

Heufer, Jan and Hjertstrand, Per, Homothetic Efficiency (July 6, 2014). Available at SSRN: https://ssrn.com/abstract=2561207 or http://dx.doi.org/10.2139/ssrn.2561207

Jan Heufer (Contact Author)

Erasmus University Rotterdam (EUR) - Department of Applied Economics ( email )

Netherlands

Tinbergen Institute ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Per Hjertstrand

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

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