Consumer preferences in CGE models when data are scarce: comparing the linear expenditure and the indirect addilog systems

Abstract

The linear expenditure system (LES) is a popular option for modeling consumer preferences in computable general equilibrium (CGE) models when data are scarce, since its underlying functional form is parsimonious in parameters. The goal of this paper is to compare the performance of LES against the indirect addilog system (IAS), a hardly known alternative, in terms of their theoretical properties and in a case study. Both systems are equally easy to implement and require the same information for parameter calibration. IAS, however, offers a richer description of consumer preferences. On the basis of an expenditure survey of Statistics Palestine in 1998, we find overwhelming statistical evidence that the IAS demand equations perform better than those of the LES. Simulations with a CGE model developed for disaster impact analysis applied to the intifada of the early 2000s show that the absolute value of the equivalent variation is larger for IAS than for LES.