On the Welfare Cost of Consumption Fluctuations in the Presence of Memorable Goods

78 Pages Posted: 30 Aug 2013

See all articles by Rong Hai

Rong Hai

University of Miami - School of Business Administration - Department of Economics

Dirk Krueger

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Andrew Postlewaite

University of Pennsylvania - Department of Economics

Multiple version iconThere are 5 versions of this paper

Date Written: August 2013

Abstract

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.

Suggested Citation

Hai, Rong and Krueger, Dirk and Postlewaite, Andrew, On the Welfare Cost of Consumption Fluctuations in the Presence of Memorable Goods (August 2013). NBER Working Paper No. w19386, Available at SSRN: https://ssrn.com/abstract=2318288

Rong Hai (Contact Author)

University of Miami - School of Business Administration - Department of Economics ( email )

P.O. Box 248126
Coral Gables, FL 33124-6550
United States

HOME PAGE: http://https://sites.google.com/site/ronghaiecon/

Dirk Krueger

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6691 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~dkrueger/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Andrew Postlewaite

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-7350 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~apostlew

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