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Abstract:

Journal article
Measuring Aggregate Price Indices with Taste Shocks: Theory and Evidence for CES Preferences
Stephen J. Redding and David E. Weinstein February 2020
Paper No' :


Tags: consumer economics; empirical analysis; measurement and data on national income and product accounts and wealth;

We develop an approach to measuring the cost of living for CES preferences that treats demand shocks as taste shocks that are equivalent to price shocks. In the presence of relative taste shocks, the Sato-Vartia price index is upward biased because an increase in the relative consumer taste for a variety lowers its taste-adjusted price and raises its expenditure share. By failing to allow for this association, the Sato-Vartia index underweights drops in taste-adjusted prices and overweights increases in taste-adjusted prices, leading to what we call a "taste-shock bias." We show that this bias generalizes to other invertible demand systems. © 2019 The Author(s).