Measurement of Consumption efficiency in Price-Quantity Space: A Distance Function Approach

In standard consumer demand analysis, it is implicitly assumed that consumers behave optimally and, thus, efficiently. However, optimality is a restrictive assumption to make for consumers' actual behaviour. This study moves away from this restrictive assumption and develops a theoretical model for the analysis of consumer's inefficiency in price-quantity space. The consumption efficiency measures which are developed allow consumer's efficiency to be studied not only in terms of budget that is wasted (i.e., as in the past attempts to study consumption efficiency in price-quantity space), but also in terms of quantities that are wasted. As regards to the empirical measurement of consumer's efficiency, an approach is proposed under which estimation of a distance function representing consumer's preferences is carried out via treatment of the unobserved utility level as a random error term.