Intra-temporal Substitution between Tradable and Nontradable Goods: Evidence from the Japanese Cross-sectional Survey Data

Using survey-based Japanese household data, this study estimates the elasticity of intra-temporal substitution (EIS) between tradable and nontradable goods. Thus, this research is related to the Backus-Smith puzzle (1993), which states the nontradable sector and low substitution between these goods are the reasons for non- conformance to the purchasing power parity theory. Among other conclusions, we confirm that consumption behavior differs among households with different social backgrounds. Furthermore, we find that the EIS is overestimated when household characteristics and time dimensions are not taken into account in the consumption function. Indeed, the EIS is low and close to zero when properly estimated, thereby confirming a cause of the Backus-Smith puzzle. Based on these findings, we conclude that prices are less decisive factors in determining the consumption composition than what the standard economic theories predict. In contrast, social factors such as age, cohort, and family size are more directly associated with consumers' allocation of goods and services.