Economics of the Family (1): Measuring Living Costs at the Household Level

This is the first of a series of posts on the economics of the family, based on lectures and in-class discussions of Professor Amar Hamoudi‘s seminar course on this topic.

The central discussion of our first class was a fundamental question in economic research and policy design: how should we define poverty? An economics student might think naively construct a minimum income threshold as the poverty line, but this effectively classifies all infants as poor. While children do not earn an income, they enjoy food and housing which are shared among family members. This extremely example highlights the public good nature of domestic goods and services and calls for measures of well-being that takes demographic composition into consideration.

To make households with different demographic characteristics comparable, we need to make select a reference household structure and use equivalence scales, which are “measures of the relative costs of living of families of different sizes and compositions that are otherwise similar” (Citro and Michael, 1995). For example, if the equivalence scale of a single adult family is 0.5 and the reference family has two adults and two children, then a single adult can live as well as a family of two adults and two children while spending only half as much. For economists, equivalence scales directly measures the impact of changes in demographic composition on the cost of living.

An example of the policy application of equivalence scales is Mollie Orshansky’s calculation of poverty thresholds in the US (Orshansky, 1965). Orshansky used USDA “economy food plan” to compute the food costs for families of different size and composition, and then adjust for the fraction of expenditure spent on food.

It is useful to narrow our scope to calculating the costs of an additional household member, in particular, an additional child. This calculation can be done using the Engel Curve or Rothbarth measure (Nelson, 1993). Engel equivalence scales draw from empirical evidence that the share of food expenditure decreases as families become better off, and compute the costs of a child to be the compensated income needed for a family to restore its share of food expenditure before the childbirth. By contrast, Rothbarth estimates child costs by selecting a group of adult goods (such as alcohol and adult clothing) and calculating the income needed to restore the consumption of these goods. Deaton and Muellbauer (1986) innovatively modeled changes in the demographic composition of the family as variations in the prices of goods (food and nonfood, for the simplest case). Consumption demand for different goods is regressed on the adjusted “prices” and duality is used to interpret the results.

At the end of the lecture, Amar raised two interesting points for further discussion. First, why do we measure everything at the household level? Assume there are two households, each including one elderly couple with the same level of household income. Couple A cooks dinner for their son who lives just next door (but not in their house), while couple B only takes care of themselves. Which couple is better off? Maybe they are equally well off because couple A might gain utility from cooking for their son. But the question does not stop here. We need to ask if the son brings additional income to the household or share resources with his elderly parents. In this case, public goods provision and resource sharing might expand well beyond the boundary of the household. In essence, we are assuming that the household is a shared consuming unit where everyone inside shares resources and reaps utilities that are inter correlated. Second, households do not only consume, they also produce. It is more realistic to model the household as a firm where production and consumption are jointly decided.

Our topic for the next class is gender and resource allocation. Looking forward to discussing about the interesting literature on intra household bargaining and gender bias in child investment.

References:
Citro, C. and Michael, R., eds. (1995). “Measuring Poverty: A New Approach“.
Deaton, A. and Muellbauer, J. (1986). “On Measuring Child Costs, with Applications to Poor Economies”. Journal of Political Economy 94(4): 720-744.
Nelson, JA. (1993). “Household Equivalence Scales: Theory versus Policy?” Journal of Labor Economics 11(3): 471-493.
Orshansky, M. (1965). “County the Poor: Another Look at the Poverty Profile.” Social Security Bulletin (January 1965): 3-29.

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One thought on “Economics of the Family (1): Measuring Living Costs at the Household Level

  1. Pingback: Economics of the Family (2): Defining “Family” | Maryandmusic's Blog

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