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On the Welfare Cost of Consumption Fluctuationsin the Presence of Memorable Goods

  • Rong Hai


    (Department of Economics, University of Chicago)

  • Dirk Krueger


    (Department of Economics, University of Pennsylvania)

  • Andrew Postlewaite


    (Department of Economics, University of Pennsylvania)

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 propose 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 household-level 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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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 13-046.

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Length: 17 pages
Date of creation: 23 Aug 2013
Date of revision:
Handle: RePEc:pen:papers:13-046
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  9. Abel, A.B., 1990. "Asset Prices Under Habit Formation And Catching Up With The Joneses," Weiss Center Working Papers 1-90, Wharton School - Weiss Center for International Financial Research.
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  14. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
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  19. Olga Gorbachev, 2007. "Did Household Consumption Become More Volatile?," ESE Discussion Papers 161, Edinburgh School of Economics, University of Edinburgh.
  20. Robert E. Hall & Frederic S. Mishkin, 1980. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," NBER Working Papers 0505, National Bureau of Economic Research, Inc.
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