Jäntti, Markus Kanbur, Ravi Nyyssölä, Milla Pirttilä, Jukka
Year of Publication:
WIDER Working Paper 2012/109
This paper examines the measurement of social welfare, poverty and inequality taking into account features that have been found to be important welfare determinants in behavioural economics. Most notably, we incorporate reference-dependence, loss aversion and diminishing sensitivity - aspects emphasized in prospect theory - to social welfare measurement. We suggest a new notion of equivalent income, the income level with which the individual would be as well off, evaluated using a standard concave utility function, as he or she actually is, evaluated with a reference-dependent utility function. We examine the differences between standard poverty and inequality measures based on observed income and measures that are calculated based on equivalent income. These differences are illustrated using household-level panel data from Russia and Vietnam.
prospect theory poverty inequality welfare measurement vulnerability