Economic Measurement of Consumers and Firms: A Model Consistent Approach

Abstract

The concept of model consistency is espoused as a guiding principle to balance the science and art of economic modelling. Striking a delicate balance between the theory and art of modelling is examined as a way to promote economics as a social science. This is accomplished by looking at more traditional approaches to economics, especially those encapsulated in consumer theory and the theory of the firm, and asking the question: â How can research based on these types of theory on the one hand be â scientificâ and on the other hand be responsive to â socialâ orientations such as the welfare of consumers and the profitability of firms?â A review of a diverse strand of literature shows that the significance of the methodology of model consistency has already been recognised in the macroeconomic context. However, application to the microeconomic context is rather limited. The approach is analogous to â measurement with theoryâ and may be seen as a response to the challenge that â measurement without theoryâ is as useful as â theory without measurementâ . It may also be seen as a way to address the Lucas Critique; a way to bring together theory and application, and as a good complement to experimental economics. The approach is quite suitable for consumer theory and producer theory alike. This is particularly so in a static decision-making context, where producer theory may be considered as a mirror image of consumer theory and the â atemporalâ economic problem of the firm can be analysed using similar techniques as those employed in consumer theory, especially in the single output case. Building upon the logical connection between the utility function and the single output production function, the ideas of consumer theory are carried over to the producer case through an appropriate use of duality theory. This thesis exploits the similarity between the unobservability of utility and the unobservability of â outputâ in a multi-output setting. Duality theory provides the desired rigour of economic science. The quality of its operationalisation is dependent upon the art of modelling. An appropriate mix of price index specification and statistical techniques is required to achieve the desired objectives.