Revisiting the Income Effect: Gasoline Prices and Grocery Purchases

This paper examines the importance of income effects in purchase decisions for every-day products by analyzing the effect of gasoline prices on grocery expenditures. Using detailed scanner data from a large grocery chain as well as data from the Consumer Expenditure Survey (CES), we show that consumers re-allocate their expenditures across and within food-consumption categories in order to offset necessary increases in gasoline expenditures when gasoline prices rise. We show that gasoline expenditures rise one-for-one with gasoline prices, consumers substitute away from food-away-from-home and towards groceries in order to partially offset their increased expenditures on gasoline, and that within grocery category, consumers substitute away from regular shelf-price products and towards promotional items in order to save money on overall grocery expenditures. On average, consumers are able to decrease the net price paid per grocery item by 5-11% in response to a 100% increase in gasoline prices. We find evidence that this consumer substitution effect happens given retail price adjustments due to pass-though of higher gasoline prices into retail prices, by investigating two price indexes; one that uses shelf-prices and one that uses prices net of promotional discounts (net-prices are equal to shelf-prices if there is no discount). We assess the effect of gasoline prices on each of the price indexes, controlling for store-level fixed-effects and regional time trends, finding a 5 percent increase in net prices as a result of a 100 percent increase in gasoline prices. Product prices appear to adjust flexibly with gasoline prices through the size of discounts and promotions, which change weekly (or by-weekly) even though shelf-prices remain stable. Our results show that consumers respond to permanent changes in income from gasoline prices by substituting towards lower-cost food at the grocery store and lower priced items within grocery category. The substitution away from full-priced items towards sale items has implications for microeconomic demand models as well as for macroeconomic inflation measures that typically do not incorporate frequently changing promotional prices.