Behavioral Heterogeneity and the Income Effect

Inspired by the recent literature on aggregation theory, this paper introduces HITS, a semiparametric model of consumer demand that allows for diversity in tastes. The strong variation of budget shares observed across income strata can arise from two economic factors: the individual income effect, and taste differences between poor and rich households. Consumer expenditure surveys that report repeated cross-sections do not permit the direct measurement of these two effects, and the paper solves this difficulty by developing a new microeconometric framework. We model consumer demand by a class of Nearly Ideal Demand Systems parameterized by a unique taste parameter. Linear heterogeneity allows GMM estimation of the structural coefficients on an aggregate time series, and the joint density of spending and tastes is recovered from cross-sections by a nonparametric procedure involving a deconvolution. We develop an asymptotic theory and demonstrate the accuracy of the algorithm by Monte Carlo and bootstrap simulations. The model is estimated on four size groups using the British Family Expenditure Survey (1968-98). We report a strong correlation between income and tastes, which explains most of the observed variation of budget shares with income. Unlike some earlier models, this new approach is consistent with both the yearly cross-sections of individual choices and the dynamics of aggregate shares