Ruhr Economic Papers

Ruhr Economic Papers #496

Homothetic Efficiency. A Non-Parametric Approach

by Jan Heufer and Per Hjertstrand

TU Dortmund, 08/2014, 30 S./p., 8 Euro, ISBN 978-3-86788-569-0 DOI: 10.4419/86788569

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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.

JEL-Classification: C14, D11, D12

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

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