Testing stochastic rationality and predicting stochastic demand: the case of two goods

This paper precisely delineates the empirical content of consumer rationality in the following setting: Data are from a repeated cross section; unobserved heterogeneity is completely unrestricted; however, there are only two goods. Simple closed-form expressions determine whether (population level) data are consistent with these assumptions. Bounds on counterfactual distributions of demand, and parameters thereof, follow. A striking finding is that any rationalizable collection of cross-sectional distributions can be rationalized by pretending that the ordering of individual consumers on the budget line is maintained across budgets. Hence, this seemingly strong assumption does not tighten the bounds.