Measuring Aggregate Price Indexes with Taste Shocks: Theory and Evidence for CES Preferences
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 term a “taste-shock bias.” We show that this bias generalizes to other invertible demand systems.
Previously circulated as “A Unified Approach to Estimating Demand and Welfare.” We are especially grateful to the editor, five anonymous referees, Dave Donaldson, Pablo Fajgelbaum, Rob Feenstra, Pete Klenow, and Nick Bloom for helpful comments. We are also grateful to many other colleagues and conference and seminar participants for their helpful comments. We also thank Anna Blender, Molly Borden, Mark Greenan, Mathis Maehlum, Anders Nielsen, Rafael Parente, Dyanne Vaught and Yingjie (Angela) Wu for excellent research assistance. We also want to thank Young and Rubicam for sharing their brand asset value data. All results are calculated based on data from The Nielsen Company (US), LLC and provided by the Marketing Data Center at The University of Chicago Booth School of Business. Responsibility for the results, opinions, and any errors lies with the authors alone, and the views expressed herein are not necessarily those of the National Bureau of Economic Research.
Stephen J Redding & David E Weinstein, 2020. "Measuring Aggregate Price Indices with Taste Shocks: Theory and Evidence for CES Preferences," The Quarterly Journal of Economics, Oxford University Press, vol. 135(1), pages 503-560. citation courtesy of