Thursday, May 20, 2010

Income imputation, prices, and poverty

Consider a subsistence household that produces literally everything itself. They just really like self-sufficiency and refuse to trade for anything or maybe they are so far from any market that the transaction costs are prohibitive. Whatever the reason, they don't trade.

We'd like to know how well off this household is. Standard economic practice is to impute the value of household production based on local market prices to derive an estimate of household production and income.

Suppose the country in which this household lives opens its borders to international trade and the prices of a number of goods the household produces fall. Suppose the household, not caring either way about prices because it's not part of the market, continues production right along as it always has. Now we come along and ask how household welfare has changed.

The correct answer is: it hasn't.

The wrong answer is: prices are now lower, so clearly imputed income is lower and the household is therefore poorer.

Do food price changes affect households who neither buy nor sell that commodity? There could be secondary effects on foods the household does buy or sell, but a household that just produced rice or maize or wheat for its own consumption and didn't change behavior based on the 2006-2008 price changes is neither poorer and hungrier nor wealthier on the basis of imputed income. Secondary effects may matter. Behavior changes matter. That's about it.

Does anyone disagree?

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