Counterfactual and Welfare Analysis with an Approximate Model

Abstract: We propose a conceptual framework for counterfactual and welfare analysis for approximate models. Our key assumption is that model approximation error is the same magnitude at new choices as the observed data. Applying the framework to quasilinear utility, we obtain bounds on quantities at new prices using an approximate law of demand. We then bound utility differences between bundles and welfare differences between prices. All bounds are computable as linear programs. We provide detailed analytical results describing how the data map to the bounds including shape restrictions that provide a foundation for plug-in estimation. An application to gasoline demand illustrates the methodology.