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Measuring Aggregate Price Indexes with Demand Shocks: Theory and Evidence for CES Preferences

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  • Stephen J. Redding
  • David E. Weinstein

Abstract

We develop a new approach to measuring the cost of living for constant elasticity of substitution (CES) preferences. Our approach allows for demand shocks for individual goods (to rationalize micro data) while preserving a money-metric expenditure function (to compare the cost of living over time). We develop a new “reverse-weighting” estimator of the elasticity of substitution between goods and provide upper and lower bounds to the true parameter value. We show that abstracting from demand shocks introduces a “consumer-valuation bias,” which is analogous to the well-known “substitution bias,” and results in a substantial overestimate of the increase in the cost of living over time.

Suggested Citation

  • Stephen J. Redding & David E. Weinstein, 2016. "Measuring Aggregate Price Indexes with Demand Shocks: Theory and Evidence for CES Preferences," NBER Working Papers 22479, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22479
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. The case for a higher inflation target gets stronger
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2017-04-03 17:48:01

    Citations

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    Cited by:

    1. Oulton, Nicholas, 2018. "GDP and the system of national accounts: past, present and future," LSE Research Online Documents on Economics 87178, London School of Economics and Political Science, LSE Library.
    2. Stephen J. Redding & David E. Weinstein, 2017. "Aggregating from Micro to Macro Patterns of Trade," NBER Working Papers 24051, National Bureau of Economic Research, Inc.
    3. Timo Boppart & Peter Klenow & Huiyu Li & Antonin Bergeaud & Philippe Aghion, 2017. "Missing Growth from Creative Destruction," 2017 Meeting Papers 759, Society for Economic Dynamics.
    4. Thibault Fally & Benjamin Faber, 2016. "Firm Heterogeneity in Consumption Baskets: Evidence from Home and Store Scanner Data," 2016 Meeting Papers 381, Society for Economic Dynamics.
    5. Colin J. Hottman & Ryan Monarch, 2018. "Estimating Unequal Gains across U.S. Consumers with Supplier Trade Data," Working Papers 18-04, Center for Economic Studies, U.S. Census Bureau.
    6. Andrei Matveenko, 2017. "Logit, CES, and Rational Inattention," CERGE-EI Working Papers wp593, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    7. repec:aea:jecper:v:31:y:2017:i:2:p:187-210 is not listed on IDEAS
    8. Kozo Ueda & Kota Watanabe & Tsutomu Watanabe, 2016. "Product Turnover and Deflation: Evidence from Japan," UTokyo Price Project Working Paper Series 073, University of Tokyo, Graduate School of Economics.
    9. Kristian Behrens & Yoshitsugu Kanemoto & Yasusada Murata, 2016. "On measuring welfare changes when varieties are endogenous," GRIPS Discussion Papers 16-26, National Graduate Institute for Policy Studies.
    10. repec:aea:jecper:v:31:y:2017:i:2:p:145-64 is not listed on IDEAS
    11. Martin S. Feldstein, 2017. "Underestimating the Real Growth of GDP, Personal Income and Productivity," NBER Working Papers 23306, National Bureau of Economic Research, Inc.
    12. Hulten, Charles R. & Nakamura, Leonard I., 2017. "Accounting for Growth in the Age of the Internet The Importance of Output-Saving Technical Change," Working Papers 17-24, Federal Reserve Bank of Philadelphia.
    13. Ahmad Lashkaripour & Volodymyr Lugovskyy, 2017. "National Differentiation and Industry-Wide Scale Effects," Caepr Working Papers 2017-004 Classification-, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    14. A. Bergeaud & S.Ray, 2017. "Adjustment Costs and Factor Demand: New Evidence From Firms’ Real Estate," Working papers 641, Banque de France.

    More about this item

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • E01 - Macroeconomics and Monetary Economics - - General - - - Measurement and Data on National Income and Product Accounts and Wealth; Environmental Accounts
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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