Explaining shapes of Engel curves: the impact of differential satiation dynamics on consumer behavior

Abstract

This paper presents a formal model in which differential satiation dynamics of various consumer needs explain (not only describe) the shapes of Engel curves. In the model, individuals allocate their income to various consumption categories proportional to corresponding need deprivation states, a decision making process called matching. The model allows explaining some empirical regularities that other models have difficulties accounting for. It can, for example, reconstruct that income elasticities for food tend to decrease with rising income, and that goods that are luxuries at relatively low income levels can become necessities at higher income levels. Moreover, the paper compares the Engel curves obtained from the matching model with Engel curves obtained from a utility maximization model. While both types of Engel curves are relatively similar at high income levels, at lower income levels matching and maximization lead to very different allocations of income. The paper shows that a given amount of income redistribution leads to less additional welfare when individuals follow matching behavior than when they maximize their utility. Accordingly, to obtain a given amount of additional welfare more income redistribution is needed than a policy maker who (mistakenly) assumes that individuals rationally maximize their utility predicts.