Estimates of Equivalence scale for Iranian Households

Despite its vast natural resources of oil, gas and minerals (mining), dealing with the problem of poverty  and inequality  is a serious challenge for policy makers. This challenge becomes increasingly acute as the authorities succumb, inevitably, to pressures to liberalise the economy by implementing free market principles and similar reforms. The welfare system in the Islamic Republic of Iran is quite complex with various governmental, non-governmental and para-governmental welfare organizations operating side by side. The Subsidy Targetization Act was the biggest of its kind in the history of the Islamic Republic, and that it is bound to affect the well-being of a large proportion of the population, it is rather surprising that it was introduced in such haste and without thorough planning. An equivalence scale is a measure of the cost of living of a household of a given size and demographic composition relative to the cost of living of a reference household when both households attain the same level of utility or standard of living (Lewbel and Pendakur, 2006). The method of calculating the equivalence scale is based on the Engel curve which can be argued to be a specific, restricted, representation of the Marshallian demand curve where prices are held constant and demand varies with income. We have argued, as an example of application of this approach, that this approach provides a more efficient and equitable way of compensating the consumers for the impact of the removal of price subsidies.