Inflation and Welfare with Preference Heterogeneity

Economics strives to distill information about millions of products, firms, and workers into a concise set of metrics that summarize household welfare and cost of living. These statistics are crucial for evaluating the efficacy and impact of public decisions. This research contributes to developing a comprehensive framework for defining, measuring, and analyzing individual and aggregate welfare taking into account household heterogeneity. This work encompasses several key components. First, it introduces new methodologies for measuring cost of living and inflation, accounting for the varying values different households place on goods and services. Second, it proposes novel measures of well-being that incorporate expectations about the future. Third, it offers an improved approach to comparing welfare across countries, improving upon the traditional use of GDP comparisons under purchasing power parity. Fourth, it analyzes aggregate societal welfare while considering the uneven distribution of the effects of economic changes. The advent of extensive databases tracking household-level consumer behavior has opened new avenues for research. By developing more flexible, data-intensive approaches to conceptualizing and measuring welfare, this project leverages the wealth of microeconomic data to provide decision makers with more accurate and nuanced insights into individual and societal well-being. The aggregation of microeconomic behavior into macroeconomic outcomes has undergone significant theoretical advancements in recent decades. While substantial progress has been made in incorporating heterogeneity into production and consumption functions, the treatment of preference heterogeneity in goods consumption has lagged. This research addresses this gap by analyzing economies where the standard assumptions of stability (in the time dimension), symmetry (in the cross-section), and homotheticity (in income and wealth) in preferences are relaxed. This research develops a framework that accommodates variations in household preferences across income levels, demographic characteristics, and time periods. This approach challenges the conventional use of simple, homogeneous preference structures in macroeconomic models, which often rely on Divisia indices for welfare measurements. Allowing for non-homothetic and heterogeneous preferences introduces conceptual and practical complexities in welfare measurement that cannot be captured by traditional methods. For example, measures of welfare that take prices as given differ from those that take technologies (rather than prices) as given. The implications of this work extend to both short-term economic phenomena, such as business cycle fluctuations and inflation dynamics, and long-term structural changes, including sectoral transformations and the distributional effects of globalization. The methodology developed in this project provides a more nuanced understanding of aggregate welfare, accounting for the diverse ways in which economic changes impact different segments of society. This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.