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

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  • Stephen J. Redding
  • David E. Weinstein

Abstract

We develop an approach to measuring the cost of living for CES preferences that treats demand shocks as taste shocks that are equivalent to price shocks. In the presence of relative taste shocks, the Sato-Vartia price index is upward biased because an increase in the relative consumer taste for a variety lowers its taste-adjusted price and raises its expenditure share. By failing to allow for this association, the Sato-Vartia index underweights drops in taste-adjusted prices and overweights increases in taste-adjusted prices, leading to what we term a “taste-shock bias.” We show that this bias generalizes to other invertible demand systems.

Suggested Citation

  • Stephen J. Redding & David E. Weinstein, 2016. "Measuring Aggregate Price Indexes with Taste 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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    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

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    2. 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.
    3. 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.
    4. 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.
    5. Matveenko, Andrei, 2020. "Logit, CES, and rational inattention," Economics Letters, Elsevier, vol. 186(C).
    6. David Baqaee & Ariel Burstein, 2021. "Welfare and Output with Income Effects and Demand Instability," NBER Working Papers 28754, National Bureau of Economic Research, Inc.
    7. Erica L. Groshen & Brian C. Moyer & Ana M. Aizcorbe & Ralph Bradley & David M. Friedman, 2017. "How Government Statistics Adjust for Potential Biases from Quality Change and New Goods in an Age of Digital Technologies: A View from the Trenches," Journal of Economic Perspectives, American Economic Association, vol. 31(2), pages 187-210, Spring.
    8. Philippe Aghion & Antonin Bergeaud & Timo Boppart & Peter J. Klenow & Huiyu Li, 2019. "Missing Growth from Creative Destruction," American Economic Review, American Economic Association, vol. 109(8), pages 2795-2822, August.
    9. Katharine G. Abraham & Ron S. Jarmin & Brian Moyer & Matthew D. Shapiro, 2020. "Big Data for Twenty-First Century Economic Statistics: The Future Is Now," NBER Chapters, in: Big Data for Twenty-First Century Economic Statistics, National Bureau of Economic Research, Inc.
    10. 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.
    11. 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.
    12. 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.
    13. Martin Feldstein, 2017. "Underestimating the Real Growth of GDP, Personal Income, and Productivity," Journal of Economic Perspectives, American Economic Association, vol. 31(2), pages 145-164, Spring.
    14. Ahmad Lashkaripour & Volodymyr Lugovskyy, 2017. "National Differentiation and Industry-Wide Scale Effects," CAEPR Working Papers 2017-004, Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington.
    15. Charles Hulten & Leonard Nakamura, 2017. "Accounting for Growth in the Age of the Internet: The Importance of Output-Saving Technical Change," NBER Working Papers 23315, National Bureau of Economic Research, Inc.
    16. Shanlang Lin & Prithvi Raj Dhakal & Zhaowei Wu, 2021. "The Impact of High-Speed Railway on China’s Regional Economic Growth Based on the Perspective of Regional Heterogeneity of Quality of Place," Sustainability, MDPI, Open Access Journal, vol. 13(9), pages 1-24, April.
    17. David Atkin & Benjamin Faber & Thibault Fally & Marco Gonzalez-Navarro, 2020. "Measuring Welfare and Inequality with Incomplete Price Information," NBER Working Papers 26890, National Bureau of Economic Research, Inc.
    18. A. Bergeaud & S.Ray, 2017. "Adjustment Costs and Factor Demand: New Evidence From Firms’ Real Estate," Working papers 641, Banque de France.

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    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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