IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/22479.html
   My bibliography  Save this paper

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

Author

Listed:
  • 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
    Note: ITI
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w22479.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Behrens, Kristian & Kanemoto, Yoshitsugu & Murata, Yasusada, 2014. "New trade models, elusive welfare gains," CEPR Discussion Papers 10255, C.E.P.R. Discussion Papers.
    2. Christian Broda & David E. Weinstein, 2006. "Globalization and the Gains From Variety," The Quarterly Journal of Economics, Oxford University Press, vol. 121(2), pages 541-585.
    3. James E. Anderson & Eric van Wincoop, 2003. "Gravity with Gravitas: A Solution to the Border Puzzle," American Economic Review, American Economic Association, vol. 93(1), pages 170-192, March.
    4. Paul Krugman & Anthony J. Venables, 1995. "Globalization and the Inequality of Nations," The Quarterly Journal of Economics, Oxford University Press, vol. 110(4), pages 857-880.
    5. Charles I. Jones & Peter J. Klenow, 2016. "Beyond GDP? Welfare across Countries and Time," American Economic Review, American Economic Association, vol. 106(9), pages 2426-2457, September.
    6. Feenstra, Robert C, 1994. "New Product Varieties and the Measurement of International Prices," American Economic Review, American Economic Association, vol. 84(1), pages 157-177, March.
    7. 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.
    8. Louis Anthony Cox Jr. & Weihsueh A. Chiu & David M. Hassenzahl & Daniel M. Kammen, 2000. "Response," Risk Analysis, John Wiley & Sons, vol. 20(3), pages 295-296, June.
    9. Jerry A. Hausman, 1996. "Valuation of New Goods under Perfect and Imperfect Competition," NBER Chapters, in: The Economics of New Goods, pages 207-248, National Bureau of Economic Research, Inc.
    10. Christian Broda & David E. Weinstein, 2010. "Product Creation and Destruction: Evidence and Price Implications," American Economic Review, American Economic Association, vol. 100(3), pages 691-723, June.
    11. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    12. Andrew B. Bernard & Stephen J. Redding & Peter K. Schott, 2007. "Comparative Advantage and Heterogeneous Firms," Review of Economic Studies, Oxford University Press, vol. 74(1), pages 31-66.
    13. Chang-Tai Hsieh & Peter J. Klenow, 2009. "Misallocation and Manufacturing TFP in China and India," The Quarterly Journal of Economics, Oxford University Press, vol. 124(4), pages 1403-1448.
    14. Timothy F. Bresnahan & Robert J. Gordon, 1996. "The Economics of New Goods," NBER Books, National Bureau of Economic Research, Inc, number bres96-1.
    15. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-666, September.
    16. Krugman, Paul, 1991. "Increasing Returns and Economic Geography," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 483-499, June.
    17. Gloria Sheu, 2014. "Price, Quality, and Variety: Measuring the Gains from Trade in Differentiated Products," American Economic Journal: Applied Economics, American Economic Association, vol. 6(4), pages 66-89, October.
    18. Daniel McFadden & Kenneth Train, 2000. "Mixed MNL models for discrete response," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(5), pages 447-470.
    19. Steven T. Berry, 1994. "Estimating Discrete-Choice Models of Product Differentiation," RAND Journal of Economics, The RAND Corporation, vol. 25(2), pages 242-262, Summer.
    20. Robert C. Feenstra & Marshall B. Reinsdorf, 2007. "Should Exact Index Numbers Have Standard Errors? Theory and Application to Asian Growth," NBER Chapters, in: Hard-to-Measure Goods and Services: Essays in Honor of Zvi Griliches, pages 483-513, National Bureau of Economic Research, Inc.
    21. Colin J. Hottman & Stephen J. Redding & David E. Weinstein, 2016. "Quantifying the Sources of Firm Heterogeneity," The Quarterly Journal of Economics, Oxford University Press, vol. 131(3), pages 1291-1364.
    22. Benassy, Jean-Pascal, 1996. "Taste for variety and optimum production patterns in monopolistic competition," Economics Letters, Elsevier, vol. 52(1), pages 41-47, July.
    23. Chad Syverson, 2017. "Challenges to Mismeasurement Explanations for the US Productivity Slowdown," Journal of Economic Perspectives, American Economic Association, vol. 31(2), pages 165-186, Spring.
    24. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    25. repec:hhs:iuiwop:430 is not listed on IDEAS
    26. Caves, Douglas W & Christensen, Laurits R & Diewert, W Erwin, 1982. "The Economic Theory of Index Numbers and the Measurement of Input, Output, and Productivity," Econometrica, Econometric Society, vol. 50(6), pages 1393-1414, November.
    27. Triplett, Jack E, 2001. "Should the Cost-of-Living Index Provide the Conceptual Framework for a Consumer Price Index?," Economic Journal, Royal Economic Society, vol. 111(472), pages 311-334, June.
    28. Diewert, W. E., 1976. "Exact and superlative index numbers," Journal of Econometrics, Elsevier, vol. 4(2), pages 115-145, May.
    29. Timothy F. Bresnahan & Robert J. Gordon, 1996. "Introduction to "The Economics of New Goods"," NBER Chapters, in: The Economics of New Goods, pages 1-26, National Bureau of Economic Research, Inc.
    30. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-890, July.
    31. Jacques-Francois Thisse & Philip Ushchev, 2016. "When Can A Demand System Be Described By A Multinomial Logit With Income Effect?," HSE Working papers WP BRP 139/EC/2016, National Research University Higher School of Economics.
    32. Angus Deaton, 1998. "Getting Prices Right: What Should Be Done?," Journal of Economic Perspectives, American Economic Association, vol. 12(1), pages 37-46, Winter.
    33. Christian Broda & David E. Weinstein, 2006. "Globalization and the Gains From Variety," The Quarterly Journal of Economics, Oxford University Press, vol. 121(2), pages 541-585.
    34. Sato, Kazuo, 1976. "The Ideal Log-Change Index Number," The Review of Economics and Statistics, MIT Press, vol. 58(2), pages 223-228, May.
    35. Jessie Handbury, 2019. "Are Poor Cities Cheap for Everyone? Non-Homotheticity and the Cost of Living Across U.S. Cities," NBER Working Papers 26574, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Citations

    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

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    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. 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.
    4. Andrei Matveenko, 2017. "Logit, CES, and Rational Inattention," CERGE-EI Working Papers wp593, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    5. 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.
    6. 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.
    7. 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.
    8. Kozo Ueda & Kota Watanabe & Tsutomu Watanabe, 2016. "Product Turnover and Deflation: Evidence from Japan," CARF F-Series CARF-F-400, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    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. 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.
    11. 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.
    12. 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.
    13. David Atkin & Benjamin Faber & Thibault Fally & Marco Gonzalez-Navarro, 2020. "A New Engel on Price Index and Welfare Estimation," NBER Working Papers 26890, National Bureau of Economic Research, Inc.
    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:22479. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: http://edirc.repec.org/data/nberrus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.