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ECN 230 Winter 2017

Thiago de Lucena Coelho

Department of Economics, U.C.-Davis

Readers Response to Chetty, & Looney (2006)

Chetty, & Looney (2006) develops a theoretical model in order to explain welfare conse- quences of social insurance. The article has one simple conclusion, that is to challenges the traditional view that the social benefits of insurance are small given that fluctuations in consumption decurrent of income shocks are also small. In order to do so the article develops a theoretical model where the losses in welfare of social insurance depend directly on the consumption variation and on the relative coeficient of risk aversion. In practice, only consumption variations are observed, hence some assume that a small fluctuation in consumption would lead to small losses in welfare. Authors show, however, that this is not necesserally true. It is possible that a high risk aversion parameter leads small changes in consumption, but that this high risk aversion by itself also generates a large increase in the welfare loss function. In other words, because of the inverse relation of risk and change in consumption it is natural that a high coeficient of risk aversion leads to low consumption.

Hence, when low changes in consumption are observed we may have two scenarios. The first is that consumption is low is low because the coefficient of risk aversion is low but the cost of getting an additional unit of consumption is low. In this case, the benefits of social insurance may indeed be small. However, we may also be on the case where, the consumption is low because risk aversion is high and the cost of getting an additional unit is high. In this case welfare loses may still be high and society may benefit from insurance.

The article makes a clear, well fundamented point that challenges conventional literature. Nonetheless there are still a few points where authors could consider changes for the sake of completeness. Starting with the functional form for desutility of consumption, it would be useful if author discussed the particular empirical reasons for assuming an linear function. It seems unreasonable to me that the desutility of obtaining a certain consumption level to be linear. Practically, it is more likely that the disutility of the obtaining the first units of con- sumption is low since considering anecdotal evidence, people enjoy working small amounts of time. However once we move up in consumption level, the marginal cost becomes larger. Moreover, it is important to understand how sensitive the conclusions of the paper are to different functional forms for the disutility of consumption.

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Another interesting question unexplored in the article is the robustness of results to different utility functions. Clearly, the utility function chosen, CRRA, is one of the most general utility functions but a particular case not particularly associated with that form is the Stone-Geary. This function is particularly interesting because forces a subsistence level of consumption, which may be appropriate when analyzing households in low income set ups. Hence, repeating exercise done in section 3 or in table 1 for other utility functions could be an insightful analysis.

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