Two models have been extensively used to study preference heterogeneity

in various contexts: the CES utility functiofi and the logit discrete choice
model. Examples of both abund in the literature. For the CES. e nixit
and Stiglitz (1977) in monopolistic compefition, Atkinson and Stigk (1980)
in tax incidence, Katsoulacos (1984) in te&uologkai innovation, ~e~prn~~n
and ICrugman (1985) in international trade, etc. For the logit, see Domencich
and McFadden (1975) in transport modal choice, Anas (1982) in residential
location, de Falma et al. (1985) in spatial competition, Train et rl. (1957) in
telephone demand, etc.
These two mod& are especially popular m regional science as
by most of the papers contained in this issue.

The firstauthor thanks the Mgian govemment for financial support under the ‘Projet
d’ktion Cmmke’, contract ?4/8965.
**We haye learned from a referee that some materials p sted in 3 have
developed independently by A. Anas.

0166-0452/88/$3.50 0 1988, Elsevierscience Publishers B.V. (North-WoIland)

156 S.P. Andersonet al., Two remted nmdeisof kterogeneity

In this paper we intend to explore the linkages between the CES and the
logit. Indeed, we find they have similar roots in that the CES can be
interpreted as a s fit discrete choice model, wh% the logit can
interpret& as a representative consumer model. n the former case, we
that the demand system generated from a CES tility is formally
to the solution of a nested logit model in which the second stage is descri
terministic Cobb- utility function. In the latter case, we find
logit demands c associated with a representative consumer
maximizing a deterministic utility of the entropy type.

te e
Consider an economy with n+ 1 perfectly divisible commodities and N
consu income y. Commodities i = 1,. . . , n are the variants
of a uct; odity 0 is the (outside) composite
commodity.
The CES representative consumer supposes that the N consumers can be
represented by a preference ordering given in its simplest form by

with Os;p$l and RBO.

This utility is maximized subject to the budget constraint

f piXi+poXO'F (2)
,. i=l

where pi is the price of commodity & i=O,. . . , n, and Y = Ny the aggregate

income. ‘Theassociated demand functions for i= 1,. . . , n are

where 5”= 1 +ar) is the amount spent on the differentiated product.

Clearly, (3) can ‘bewritten as

(A”
.‘A’

this expression suggests that (4) can be obtained as the outcome

statisti~lly identical consumers.
 S.B. Anderson et al., Two related models of heterogeneity

Suppose that the ~utco e of the first stage is i.

conditionaj direct utility of a consttimer is

U~=lI11Xi+lXlllX~, i=ll (5)

where Xi is the individuaS CQ~S ef 5 and x0 that cuffthe composite

commodity, the maximiTation of (5) subject to the budget constraint
R
c i = 1 &Xi -I- p$So = y yields

xi = j/Pi9 (6)

where j7= y/(1 + a). The expression (6) is in the spirit of the first factor of (4).
The conditional indirect utility is therefore

tiPi) = -“unp,+(l +a)InJ+a(lna-lnp,). (7)

We now assume that the first stage is described by a stochastic utility

approach, i.e.,

~=V(pi)+jA?&i, i= l,...,n, (8)

where p is a positive constant and Ei a random variable with zero mean and
unit variance. If the Ei are independently, kientica!!y Curnbel-distributed, the
the probability for a consumer to choose i is given by the logit, i.e.,
.amj;p
Pr (i) = Pr( K= max vi, = nr eVhpil,rc
/=l....,n c *=1

csee acFadden (10?2)]. Given (3), (9) becomes

-lb
Pr(i)=J+
c ‘=fpj

which is identical to the seccnd factor of (4)

MuhipIying (6) by (10) yields the expected in
sumwing over tkp i\i c~~~~SUp_~:TE&ST&
F: -. = - \4J
’ != -
Thus, ehe L.&?m?n?ad m&?s’ &rived from the @

solution qf n nested Cogit model with M cons

&teministic with condiuionczr”direct utility
158 S.P. Anderson et d., Two dated siodeis ofheterogenkty

according to a specific discrete model. The analysis naturally leads to the

reverse question: can a standard discrete choice model be similarly represen-
ted, and if so, what are the properties of the resulting preference ordering? As
an example, we use here the logit and derive an assoeiated representation.
owever, the princi les uncovered ean \le applied to other problems.
Again let us consider N consumers with per capita income y. The standard
discrete choice model assumes that each consumer chooses a single variant at
price pi with an (indirect) stochastic utility given here by

hen the ei are independently, identically Gum -distributed, the proba-

bility for the consumer of choosing i is given by the logit

e - PilP
_“^._
FrjijZXi= n
-=,e
- Pj!C (12)
c

[compare to (8) and (913.

Let us now interpret (12) as the fraction of i purchased by a representative
consumer buying N units of the difkentiated product. His/her total demand
for i is therefore

Again, let Y = Yy be the income of the representative consumer. We assume

that x pO, . . . , pn are such that the budget constraint

i pjx;-i-poxo=Y
j=l

is satisfied for positive X,,. From (14), it immediately follows that the
site co odity is given by

ies the following properties which

 S.P. Aderson et al., Two related modelsofhemogeaeity
as9

There isno income effect this

which is always negative.

aXi-NX’Xi
aPj PPO

which shows that the variants of the d ntiated prod& ar etric

substitutes.

TX- shows that demand for commodity i rises (falls) with the price of the
uxnposite commodity when pi e s (is less than) the
average price of the variants. In ly, commodity i
more (less) attractive because its relative opportunity cost in terms of the
composite commodity decreases (increas$ GSp. rises.

ax,
c-
1
aY -E’
This is evident from (16).

(21)

As
A
c Xi=1 and
j=l

c Pjxj-
j=l
2
 S.P. Andersonet al., Two t-elatedmodelsofheterogeneity

The first term is the income effect [see (2O)J and, as will apparent from
the substitution matrix below, the second term is the substitution e&ct.
We now determine whether or not the demand system (13) and (15) can
from the maximization of a utility function; that is, can the Is
f discrete choice be represented by a model of utihty
~o~ti~uo~ choice? hethe: or not a demand system
a utility function is known as the ‘inte~ab~ty problem’.
if the matrix of substitution is symmetric and ne
~a~~~A(1965, p. 136)]. From the Slutsky equati
terms are

i%i 8Xi +ax, x

apj -apj Z j’ (23)

where hi is the compensated demand for commodity i. For tbp t-&t Aems=A
CLII.“E”. Y”II.UI.Y
aFu;err?,using (16~(22), we have the following substitution matrix S:

XIX2 ... -pa pi, \

--
0
I
=i PO >

P2
-- pi,
x1x2 -x2(1-x2) ... c
X2! PO I PO j >

(24)

ence the matrix is s etric. It is also negative semidefinite (see appendix);

in aaord with neo&ssica.l theory of consumer
havior, the diagonal terms ahJ8Pi, i=O, 1,. . . , n, are -positive. A utility
SCfound to ;zprGeiL the lO@i 1.
t determine such a function, consider the case
for the variants are ind tit of income and
ction of the &IVC~

ituti r
Incqmating (27) into (26) and integmti.ng89 recwer U:

u(Xl,l -x1)= -&qInx,+(l-X,)ln(l-x~)).

Hence with (Z), we have the utiiity fun&On

U= -NCc(xl lnx, +(l -xI)ln(l-~,))-kXo.

This suggests the folloxing generalization:

-fl i Xjhl~+.X*~ if + Xj=M,

j=l j*l
U=

-m otherwise.

Itis proved in An rson et al. (1988) rhat when (28) is maximize

t0 (141, we dci indeed get (12) for xi - the lOgit,
The term
expresses the variety-seeking behavior of the ~epreszz:zticz ~~z.mwr. Cete
par&us, the larger is p, the greater is th
the consumer buys only the variant wi
consumption of the d~~~~~~~~~t~dpr
variants. Some a.dditional properties o
TPL .
1 ;;e ecriT;&;“Qn
several authors [see, e.
consumr tkc~,v provid
the CES utility is maxi
of these two models is more suitabk &
situation studied.
Tha is another major a~~~o~~ t@
n&y which we have

eristics model, as
possible only when the fium-her of
to the number of vGants.
To illustrate these ideas for the logic the ter c is interpreted iu the
discrete choice model as the city in consumer tastes.
Under the representative consumer approach p can be interpreted as the
taste for diversity. In a characteristics setting, this ter indicates the
de ofdis ion ofconsumers vis-&is the prod in the characteristics
SpWXt.

Let us rewrite the detelrlainant of the principal minors of the substitution

ratrix S as

“.’ -yx2) ;I’ “.’ (A.11

.. .. . ..
4 Xi ... (1 -xi)

fix l-=1,... ,B, where Ai=( := 11x& The determinant of s is given by

 i=l,...,n W-9

SO that S@ISi(=(-S)' for i=l,..., n - 1 and I&l=O. The determinant of S is

gWzn by

Anderson, S.P., k de Ptia and I.-F. T&se, 1?8?, maad far dS%rw&trl productt d&screte
choice models and the address approach, CO discussioc pay ~0. 8702 f
Catholiqcle de Louvain, Louvain-la-Neuve, Belgium).
 S.P. Anderson et al., 7%~ related models of heterogeneity

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