On Interpreting Inverse Demand Systems: A Primal Comparison of Scale Flexibilities and Income Elasticities

Abstract

Abstract Scale flexibilities in inverse demand systems describe how marginal valuations change with expansions in the consumption bundle. Such effects clearly are related to income elasticities in direct demand systems. However, the connection is not so close as it first appears. We argue that the link between scale flexibilities and income elasticities is tight only if preferences are homothetic, a situation where neither measure is interesting, or if all elasticities of substitution are unitary. We make clear the relationship between the two measures in a coordinate system focusing on how marginal rates of substitution change with consumption scale and proportion.