Labor-Market Wedge Under Engel Curve Utility: Cyclical Substitution between Necessities and Luxuries

16 Pages Posted: 20 Aug 2018 Last revised: 21 Feb 2019

See all articles by Yongsung Chang

Yongsung Chang

University of Rochester - Department of Economics; Yonsei University - Department of Economics

Andreas Hornstein

Federal Reserve Bank of Richmond

Marios Karabarbounis

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: 2018-07-19

Abstract

In booms, households substitute luxuries for necessities, e.g., food away from home for food at home. Ignoring this cyclical pattern of composition changes in the consumption basket makes the labor-market wedge -- a measure of inefficiency that reflects the gap between the marginal rate of substitution and the real wage -- appear to be more volatile than it actually is. Based on the household expenditure pattern across 10 consumption categories in the Consumer Expenditure Survey, we show that taking into account these composition changes can explain 6-15% of the cyclicality in the measured labor-market wedge.

Keywords: economic fluctuations, equilibrium model, consumption

Suggested Citation

Chang, Yongsung and Hornstein, Andreas and Karabarbounis, Marios, Labor-Market Wedge Under Engel Curve Utility: Cyclical Substitution between Necessities and Luxuries (2018-07-19). FRB Richmond Working Paper No. 18-13. Available at SSRN: https://ssrn.com/abstract=3234199

Yongsung Chang (Contact Author)

University of Rochester - Department of Economics ( email )

Harkness Hall
Rochester, NY 14627
United States

Yonsei University - Department of Economics ( email )

50 Yonsei-Ro
Seoul, 120-749
Korea

Andreas Hornstein

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States
804-697-8266 (Phone)
804-697-8255 (Fax)

Marios Karabarbounis

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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