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The extensive margin of aggregate consumption demand

Author

Listed:
  • Claudio Michelacci

    (EIEF)

  • Andrea Pozzi

    (EIEF)

  • Luigi Paciello

    (EIEF)

Abstract
We document that around one half of the cyclical variation in aggregate non-durable consumption expenditures by US households comes from changes in the products entering their consumption basket. Most of this variation is due to changes in the rate at which households add new products to their basket, while removals from the basket are relatively acyclical. These patterns hold true within narrowly defined sectors of products or quality categories and are only partly driven by changes in the price of products or their availability in the market. We rationalize this evidence by incorporating a conventional random utility model of discrete choice of products into a standard household dynamic optimization problem. Household preferences over products in her consideration set randomly vary over time and because of this a larger set reduces the welfare relevant household price index. The household can save in financial assets and decides how much to spend in experimenting for new products to be added to her consideration set. In response to income shocks the household increases savings and experiments more, which allows to smooth consumption by persistently reducing her future price index. The calibrated model predicts that experimentation expenditures fluctuate by around 15 percent from peak to bottom in the business cycle. This experimentation channel has novel implications for consumption smoothing, the measurement of household level inflation, and the role of aggregate demand stabilization policies. Motivated by this evidence, we embed a standard discrete choice model of product choice into a macro model. Random shocks to preferences cause products to be temporarily added and removed from the consumption basket, while experimentation effort by households expands their consideration set, leading to products being added to their consumption basket. This mechanism microfunds love for variety as a household's effort to expand the consideration set to better fit its random preferences. Expansions in the consideration set have long lasting effects on household welfare, as they persistently reduce the welfare-relevant price paid by the household, providing a substitute to savings in smoothing utility from consumption expenditure over time. We calibrate the model using the scanner data to show that product experimentation is pro-cyclical, acts as a substitute to savings and accounts for a large fraction of the cyclical behavior of product addition. We validate the prediction of the model by analyzing the response to an exogenous shock to income, represented by the 2008 U.S. Fiscal Stimulus in the U.S., and showing that it led to a surge in product experimentation.

Suggested Citation

  • Claudio Michelacci & Andrea Pozzi & Luigi Paciello, 2018. "The extensive margin of aggregate consumption demand," 2018 Meeting Papers 1008, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:1008
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    Cited by:

    1. Mark Aguiar & Mark Bils & Corina Boar, 2020. "Who Are the Hand-to-Mouth?," Working Papers 2020-9, Princeton University. Economics Department..
    2. Mark Aguiar & Corina Boar & Mark Bils, 2019. "Who Are the Hand-to-Mouth?," 2019 Meeting Papers 525, Society for Economic Dynamics.

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