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On the welfare cost of consumption fluctuations in the presence of memorable goods

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  • Hai, Rong
  • Krueger, Dirk
  • Postlewaite, Andrew

Abstract

We propose a new classification of consumption goods into nondurable goods, durable goods and a new class which we call memorable goods. A good is memorable if a consumer can draw current utility from its past consumption experience through memory. We construct a novel consumption-savings model in which a consumer has a well-defined preference ordering over both nondurable goods and memorable goods. Memorable goods consumption differs from nondurable goods consumption in that current memorable goods consumption may also impact future utility through the accumulation process of the stock of memory. In our model, households optimally choose a lumpy profile of memorable goods consumption even in a frictionless world. Using Consumer Expenditure Survey data, we then document levels and volatilities of different groups of consumption goods expenditures, as well as their expenditure patterns, and show that the expenditure patterns on memorable goods indeed differ significantly from those on nondurable and durable goods. Finally, we empirically evaluate our model's predictions with respect to the welfare cost of consumption fluctuations and conduct an excess-sensitivity test of the consumption response to predictable income changes. We find that (i) the welfare cost of householdlevel consumption fluctuations may be overstated by 1:7 percentage points (11:9% points as opposed to 13:6% points of permanent consumption) if memorable goods are not appropriately accounted for; (ii) the finding of excess sensitivity of consumption documented in important papers of the literature might be entirely due to the presence of memorable goods. --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2013/24.

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Date of creation: 2013
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Handle: RePEc:zbw:cfswop:201324

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  1. Hall, Robert E & Mishkin, Frederic S, 1982. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," Econometrica, Econometric Society, Econometric Society, vol. 50(2), pages 461-81, March.
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  3. Jappelli, Tullio & Pistaferri, Luigi, 2010. "The Consumption Response to Income Changes," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7680, C.E.P.R. Discussion Papers.
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  13. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1.
  14. Browning, M. & Crossley, T., 1999. "Shocks, Stocks and Socks: Consumption Smoothing and the Replacement of Durables During an Unemployment Spell," Papers, Australian National University - Department of Economics 376, Australian National University - Department of Economics.
  15. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 107(2), pages 205-251, April.
  16. Jonathan A. Parker, 1999. "The Reaction of Household Consumption to Predictable Changes in Social Security Taxes," American Economic Review, American Economic Association, American Economic Association, vol. 89(4), pages 959-973, September.
  17. Zeldes, Stephen P, 1989. "Consumption and Liquidity Constraints: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 97(2), pages 305-46, April.
  18. Lusardi, Annamaria, 1996. "Permanent Income, Current Income, and Consumption: Evidence from Two Panel Data Sets," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 14(1), pages 81-90, January.
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  22. Martin Browning & Thomas F. Crossley, 2000. "Luxuries Are Easier to Postpone: A Proof," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 108(5), pages 1022-1026, October.
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  1. Memorable goods
    by Economic Logician in Economic Logic on 2013-10-15 14:45:00
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Cited by:
  1. Gabriela Prelipcean & Mircea Boscoianu, 2014. "Stochastic Dynamic Model on the Consumption – Saving Decision for Adjusting Products and Services Supply According with Consumers` Attainability," The AMFITEATRU ECONOMIC journal, Academy of Economic Studies - Bucharest, Romania, vol. 16(35), pages 201, February.

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