CES Utility Function Research Articles

Commensurability and Characterization of Normalization Conditions for Cost-of-Living Comparisons under Time-Varying CES Preferences

We show that the normalization conditions for a CES utility function with time-varying preferences (Redding and Weinstein, 2020) must be of weighted-geometric mean form to ensure commensurability of price indexes, and numerically illustrate failure of additive normalization to satisfy commensurability.

Less work and higher tax can raise wellbeing

AbstractWorktime has been falling slowly though real wages have risen dramatically. We show that in a general equilibrium model with CES utility and production functions, worktime falls with real wages if and only if the elasticity of substitution between consumption and leisure is less than that between capital and labour, but always rises with labour's income share and concerns with relative income. While a falling labour share may not reduce worktime due to market inflexibility, stronger income comparison increases inefficient overwork. Hence, more flexibility, higher income taxes and a basic income are needed to reduce working hours and raise social welfare.

Correlation Analysis of International Student Exchange and the Enhancement of China’s International Cultural Communication Power Based on the Subsumption Sorting Algorithm

Abstract International students are a bridge between Chinese and foreign cultures, but they still face multiple dilemmas in Chinese cultural communication due to different cultural backgrounds and values. In this paper, we utilize the subsumption sorting algorithm to sort the amount of cultural communication of international students’ exchanges, which is dynamically switched by a combination of two methods: back-block forward interpolation and header exchange. The D-S monopolistic competition model is used to construct the theoretical model of international student exchange that affects China’s international cultural communication power. The CES utility function is used to construct China’s international cultural communication network, which calculates the total amount of communication culture of cross-cultural exchanges between international students. In the end, an analysis of 85 international student samples revealed a correlation between international student exchanges and China’s international cultural communication. The results show that the correlation coefficient between international student exchanges and China’s international cultural communication is 0.305 p > 0.05, indicating that international student exchanges have a positive promotion effect on China’s international cultural communication. This study examines the general law of international cultural communication, which is crucial in promoting Chinese culture worldwide.

Empirical Properties of an Extended CES Utility Function in Representing Distributional Preferences

Empirical Properties of an Extended CES Utility Function in Representing Distributional Preferences

Revisiting CES utility functions for distributional preferences: Do people face the equality–efficiency trade-off?

Revisiting CES utility functions for distributional preferences: Do people face the equality–efficiency trade-off?

Is your netflix a substitute for your telefunken? Evidence on the dynamics of traditional pay TV and OTT in Latin America

Are audiovisual over the top (OTT) services in Latin America substitutes for the traditional Pay TV services (cable or satellite), complementary or independent? To respond to this question, we develop a simple theoretical model based on a CES utility function and estimate simultaneously, using non-linear least squares, demand functions for both audiovisual services. Our results, based on original database covering 17 Latin American countries from 2011 to 2020, suggest no substitution of Pay TV for OTT. However, during the more recent period (2015–2020), we find evidence of gross substitution (i.e., similar enough, although not completely equivalent for consumers) between these audiovisual services. This confirms, although only partially, the existence of the so-called cord-cutting and cord-saving phenomena, due to the expansion of fast internet and the richer OTT offers, and their relatively lower prices. These results suggest regulators should include OTT services in their scope and produce in-depth analysis on the country level to update and optimize regulations, as well as implement regulatory sandboxes to advance towards smart regulation, as shown in the financial industry.

The relationship between labor productivity and number of operating firms

This paper constructs a theoretical model matching empirically observed relationships between average labor productivity and the number of operating firms. The models in the related literature which utilize CES utility function find no relationship between average labor productivity and the number of operating firms in the economy (Melitz, Marc J. [2003. “The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity.” Econometrica 71 (6): 1695–1725] and many versions of this model). Moreover, the models which utilize non-homothetic preferences with a numeraire good find a positive relationship between average labor productivity and the number of operating firms (Melitz, Marc, and Gianmarco I. P. Ottaviano [2008. “Market Size, Trade, and Productivity.” Review of Economic Studies 75: 295–316] and many versions of this model). However, the model developed in this paper provides a single theoretical framework that depending on the source, a rise in the average labor productivity may lead to an increase or a decrease in the number of operating firms. In line with our results, we provide empirical evidence from ten European countries for the 2008–2016 period, which shows that the correlation between these two variables is positive for some of the countries, while negative for the others.

Markups in a two-country monopolistic competition model of trade with heterogeneous consumers

The paper develops a two-country monopolistic competition model of trade featuring country-specific consumer tastes. The accounting for heterogeneity in tastes is achieved by assuming different elasticities of substitution in the CES utility function for different country consumers. The proposed framework extends the canonical Krugman’s approach by revealing new effects regarding markups response to consumer heterogeneity and trade liberalization. Specifically, the model predicts that, depending on the preference structure, trade liberalization may lead either to decrease or increase in the level of markups, charged by monopolistically competitive firms across destination countries.

The Elasticity of Intertemporal Substitution: A Tool to Constrain Profligate Government Spending

We construct a theoretical model to explain profligate electoral fiscal behaviour and to provide a tool, namely the estimated elasticity of intertemporal substitution, for the fiscal authorities to detect and timely constrain such behaviour to promote fiscal prudence. The key is to obtain data on the incumbent party preferred sequence of public consumption levels over time. The model frames this case using a CES utility function and provides one possible mechanism to explain why there are so many examples in the empirical literature that find insignificant electoral biases in fiscal variables.

The Wage Premium and Market Structure

In this paper, we seek to understand why the “wage premium”, the percentage by which wages earned by skilled workers exceed those of unskilled workers, varies among industries featuring different market competitiveness. We construct a theoretical model with CES utility function and constant return to scale production function that allows us to examine the effects of different imperfect market structures (monopolistic competition and oligopoly) on the wage premium. We find that the wage premium is higher under oligopoly than under monopolistic competition. Our findings are supported by empirical evidence from Chilean manufacturers.

Logit, CES, and rational inattention

We study the fundamental links between two popular approaches to consumer choice: the multinomial logit model of individual discrete choice and the CES utility function, which describes a diversified choice of a representative consumer. We base our analysis on the rational inattention (RI) model and show that the demand system of RI agents, each of which chooses a single option, coincides with the demand system of a fictitious representative agent with CES utility function. Thus, the diversified choice of the representative agent may be explained by the heterogeneity in signals received by the RI agents. We obtain a new interpretation for the elasticity of substitution and the weighting coefficients of the CES utility function. Specifically, we provide a correspondence between parameters of the CES utility function, prior knowledge and marginal cost of information.

Heterogeneity of consumer preferences and trade patterns in a monopolistically competitive setting

The paper considers a two-sector two-country trade model of monopolistic competition featuring the heterogeneity of consumer preferences and incomes within and across countries. The incorporation of heterogeneity into a monopolistic competition setting is achieved by assuming a nested Cobb–Douglas and CES utility function exhibiting both country and sector-specific consumer tastes and expenditure shares on manufacturing and traditional goods. The key question analyzed in the paper is how consumer heterogeneity affects the home bias of trade in different countries. The key finding here is that the heterogeneity in tastes and incomes of consumers can provide a substantial influence on degree of home bias in trade but only in combination with high transportation costs.

The Estimation of Korea’s Export to Trans-Pacific Member Countries Using The Gravity Model

This paper analyzed the effect of the TPP on Korean economic growth using the gravity equation derived by Anderson and Wincoop (2003). The gravity model in this paper was mainly derived from CES utility function and used variables Consumer Price Index (CPI), distance, and FTA. The result throws skepticism on the benefit of TPP to Korea, even with the US as its partner country in terms of TPP. In recent days, trade amount is less influenced by physical distance but trade barriers, and the result shows the reality. The most important feature of the trade with TPP membership countries was CPI. Findings reveal that Korea CPI works very well for increasing export to TPP member countries and this trend is followed by partner countries’ CPI. However, the direction of the Korea CPI is interesting in that Korean exports increase strongly when Korea CPI increases. This implies that high Korea CPI doesn’t mean strong Korean Won to foreign currency. On the other hand, if Korean CPI increases the Korean Won value goes down which result in increasing exports to other countries.

The Complexity of Non-Monotone Markets

We introduce the notion of non-monotone utilities, which covers a wide variety of utility functions in economic theory. We then prove that it is PPAD-hard to compute an approximate Arrow-Debreu market equilibrium in markets with linear and non-monotone utilities. Building on this result, we settle the long-standing open problem regarding the computation of an approximate Arrow-Debreu market equilibrium in markets with CES utility functions, by proving that it is PPAD-complete when the Constant Elasticity of Substitution parameter ρ is any constant less than − 1.

Logit, CES, and Rational Inattention

We study fundamental links between two popular approaches to consumer choice: the multinomial logit model of individual discrete choice and the CES utility function, which describes a multiple choice of a representative consumer. We base our analysis on the rational inattention (RI) model and show that the demand system of RI agents, each of which chooses a single option, coincides with the demand system of a fictitious representative agent with CES utility function. Thus, the multiple choice of the representative agent may be explained by the heterogeneity in signals received by the RI agents. We obtain a new interpretation for the elasticity of substitution and the weighting coefficients of the CES utility function. Specifically, we provide a correspondence between parameters of the CES utility function, prior knowledge and marginal cost of information.

Cost disease in service sector

ABSTRACTA higher growth rate of the service sector prices, rather than prices in the manufacturing sector, through time is known as cost disease in the service sector. This paper investigates supply and demand-side reasons for cost disease. First, we present an analysis of the supply side of the cost disease, when services and manufacturing play their role both in the intermediate and final demand. Second, we consider a CES utility function for the consumer, which is a function of two commodity services and manufacturing. The results indicate that there are two reasons for cost disease to occur from the supply side in an economy: first, when the growth rate of total factor productivity and technological progress in services is less than that in the manufacturing sector, and second, when the elasticity of substitution between labor and manufacturing input in the services production function is large and elasticity of substitution in manufacturing production function is small. From the demand side, the result shows that the cost disease occurred if the growth rate of the income elasticity of service is more than the manufacturing sector through time.

Logit, CES, and Rational Inattention

We study fundamental links between two popular approaches to consumer choice: the multinomial logit model of individual discrete choice and the CES utility function, which describes a multiple choice of a representative consumer. We base our analysis on the rational inattention (RI) model and show that the demand system of RI agents, each of which chooses a single option, coincides with the demand system of a fictitious representative agent with CES utility function. Thus, the multiple choice of the representative agent may be explained by the heterogeneity in signals received by the RI agents. We obtain a new interpretation for the elasticity of substitution and the weighting coeficients of the CES utility function. Specifically, we provide a correspondence between parameters of the CES utility function, prior knowledge and marginal cost of information.

Advantageous redistribution with three smooth CES utility functions

We present a parametric example of three-country advantageous redistribution with two Cobb–Douglas utility functions and one CES utility function for which the elasticity of substitution is 1/2. This paper indicates that the possibility of advantageous redistribution strongly depends on the three countries’ taste patterns, endowment distributions, and the elasticity of substitution. In particular, we will show with specific examples that greater difference between the donor and recipient’s taste patterns and a lower elasticity of substitution can increase the chance of advantageous redistribution.

Heterogeneous Consumers and Trade Patterns in a Monopolistically Competitive Setting

The paper considers a two-country trade model of monopolistic competition featuring the heterogeneity of consumer preferences both within and across countries. The incorporation of heterogeneity into a traditional monopolistic competition setting is achieved by assuming different elasticities of substitution in the CES utility function for different consumers. The proposed setup expands on the traditional model of trade by demonstrating a richer set of country specific effects. The key question analysed in the paper is how consumer heterogeneity and trade liberalization affect markups and wages in different countries. Unlike the canonical CES-model of trade, where markups in different countries are constant and identical to each other, our model, by taking consumer heterogeneity into account, provides different markups across countries, incorporating both heterogeneity and trade specifics. The model also predicts that the larger of two countries engaged in costly trade may have a wage rate higher than, lower than or equal to that of the smaller one, depending on the general equilibrium conditions. This finding is in contrast to that of the canonical setting, where the larger country under costly trade always has a higher wage rate.

Are Armington elasticities different across countries and sectors? A European study

CGE models are widely used for policy evaluation and impact analysis especially with respect to trade reforms, tax reforms, energy sector reform and development policy analysis. However, the results of such models are often argued to be sensitive to the choice of exogenous parameters such as trade elasticities. Several authors show that the choice of the so-called Armington elasticities in the demand function has a strong influence on the simulation results. Most existing estimates of Armington elasticities are only for the US. The few studies for other countries find substantially differing results. Nevertheless, many CGE modelers simply adopt the elasticities from other studies disregarding specific country and model characteristics. This paper aims at providing estimated elasticities based on recent data for a larger group of European countries. Using cointegration and panel fixed effects analyses we estimate the first order condition resulting from cost minimization or utility maximization subject to the CES utility or cost function in imports and domestic goods. The results show a rather large variation across sectors and countries and the magnitude is only partly comparable to the US elasticities. Moreover, in a small CGE application we are able to show that changing the elasticity set has a quantitative and even qualitative impact on CGE model results, which confirms the concern that one might end up with biased results due to a misspecification of the elasticities.