Choice Modelling

Choice Modelling

The State of the Art and the State of Practice

Edited by Stephane Hess and Andrew Daly

Choice modelling has been one of the most active fields in economics over recent years. This valuable new book contains leading contributions from academics and practitioners from across the different areas of study where choice modelling is a key analytical technique, drawn from a recent international conference.

Chapter 7: Applied welfare economics with discrete choice models: implications of theory for empirical specification

Richard Batley and J. Nicolás Ibáñez

Subjects: economics and finance, valuation, environment, valuation

Extract

The apparatus of the Random Utility Model (RUM) first emerged in the early 1960s, with Marschak (1960) and Block and Marschak (1960) translating models originally developed for discriminant analysis in psychophysics (Thurstone, 1927) to the alternative domain of discrete choice analysis in economics. Whilst some researchers were quick to see its practical potential (e.g. McFadden, 1968, 1975), it was not until the late 1970s and early 1980s that RUM was equipped with a reasonably comprehensive theoretical rationale in terms of the economics of consumption. An important tenet of this rationale was the link between discrete choice and welfare, which established a basis for applying RUM to public policy analysis, and paved the way for the plethora of applications which have been witnessed over the last 30 years. It will be helpful to clarify precisely what we mean by ‘discrete choice’, since Small and Rosen (1981) – which will be referred to as ‘S & R’ in the remainder of this chapter – suggest three alternative rationales, as follows. First, commodities may be available in continuous quantities but only a limited number of varieties. Second, goods may be supplied in discrete units of such magnitude that only a small number of those units are typically consumed (in this case, S & R cite the example of travel mode choice).

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