Welfare evaluation in a heterogeneous agent model: How representative is the CES representative consumer?

•Asymmetric changes in prices induce differential gains across heterogeneous consumers.•Kaldor-Hicks transfers aim at redistributing income across consumers to make everyone at least as well-off as before the price change.•If the varieties are perfectly substitutable and the marginal utility of income is decreasing, the Kaldor-Hicks income transfers are not feasible-e.g., in a discrete choice model.

The present paper investigates the impact of asymmetric price changes on welfare in a model with heterogeneous consumers. I consider consumer heterogeneity à la Anderson et al. (1992). The standard welfare equivalence between the CES representative consumer and the discrete choice model breaks down in the presence of asymmetric price changes. In fact, asymmetric variations in prices produce differential gains among heterogeneous consumers. I show that there exists no feasible Kaldor-Hicks income transfer such that the gains are equally redistributed. This result suggests that only symmetric policy-induced price changes minimize the utility losses across heterogeneous consumers.