Engel functions, panel data and latent variables

Abstract

A system of consumer expenditure functions is estimated from Norwegian household budget data. Specific features o f our approach are: (I) Panel data on individual households are used, which offer far richer opportunities for identification, estimation and testing than usual cross section data. (II) Measurement errors are carefully modelled. Total consumption expenditure is modelled as a latent variable, purchase expenditures on different goods and two income measures are used as indicators of this basic latent variable. (III) The distribution of latent total expenditure across households, and its evolution over time, is estimated and important properties tested. (IV) Individual differences in preferences, represented by individual, time invariant latent variables, are modelled, identified, estimated, and tested. (V) We test the hypothesis that preferences are uncorrelated with total consumption expenditure, which is basic to all cross section estimation of consumer demand functions. (VI) The model can be formalized as a special case of the LISREL model, and the maximum likelihood algorithm of the computer program LISREL VI is applied.