Beyond the Mean: Testing Consumer Rationality through Higher Moments of Demand

TL;DR

This paper demonstrates that analyzing higher moments of demand, such as mean and variance, enables testing for rationality in aggregate consumer data, providing new insights beyond traditional restrictions.

Contribution

It introduces a novel approach using demand moments to test rationality, contrasting with classical results that show no observable restrictions in aggregate demand.

Findings

Mean and variance of demand impose observable restrictions

Moment-based methods improve demand and welfare estimates

Testing for a welfare-relevant representative consumer is feasible

Abstract

We study a setting where an analyst has access to purely aggregate information about the consumption choices of a heterogenous population of individuals. We show that observing the statistical moments of market demand allows the analyst to test aggregate data for rationality. Interestingly, just the mean and variance of demand carry observable restrictions. This is in stark contrast to impossibility result of the Sonnenschein-Mantel-Debreu theorem, which shows that aggregate demand carries no observable restrictions at all. We leverage our approach to deliver a characterization of rationality in terms of moments for the common two-good case. We illustrate the usefulness of moment-based restrictions through two applications: (i) improving the precision of demand and welfare estimates; and (ii) testing for the existence of a welfare-relevant representative consumer.