Optimization Analysis of the U.S. Aggregate Consumption: A Goodness-of-Fit Approach

Abstract

This paper examines the hypothesis of optimizing behavior of the U.S. consumers using quarterly and seasonally adjusted series on real consumer expenditures on eight commodity groups: clothing, durable goods, energy, food, housing, medical care, transportation, and others for the period of 1947:I through 1993:I. Following the Weak Axiom of Revealed Preference (WARP), a money-metric utility function is derived to calculate an efficiency index to determine the percentage difference between the observed cost of consumption and the optimum cost of consumption in each period of the sample. The empirical results provide evidence that the allocative efficiency in the U.S. has improved only slightly due to the wave of deregulations in the early 1980s. Our results are consistent with the predictions of the general theory of second best in showing that gains in the allocative efficiency may be minimal as long as many sectors of the economy remain partially or totally regulated.