Introduction

After discussing general problems of statistical and econometric inference, I will turn to a case study. This chapter deals with consumer behaviour which belongs to the best researched areas in both economic theory and econometrics.

The theory of consumer behaviour implies a number of properties of demand functions. Such demand functions have been estimated and the predicted properties have been compared with the empirical results. Among the most interesting properties is the homogeneity condition, a widely accepted piece of economic wisdom which, however, does not seem to stand up against empirical tests.

This chapter discusses why the rejections were not interpreted as Popperian falsifications of demand theory. Furthermore, the role of auxiliary assumptions is discussed. Finally, the merits of Leamer's (1978) ‘specification searches’ for interpreting the literature on testing homogeneity are assessed.

The status of the homogeneity condition: theory

Introduction

The condition of homogeneity of degree zero in prices and income of Marshallian demand functions belongs to the core of micro-economic wisdom.