Testing the aggregation of goods and services without separability using panel data

Abstract

After Japan’s bubble economy collapsed in 1991, household values diversified, and, gradually, the budget shares on intangible services exceeded that on tangible goods, leading to a shift from demand for goods to services. In this study, we focus on the increased budget allocation to services in Japanese household expenditure and verify whether service-related items can be aggregated into a service group using Lewbel’s (Am Econ Rev 86(3):524–543, 1996) generalized composite commodity theorem (GCCT). We first accurately reclassify into all 51 items consisting of goods and services and verify whether these aggregations are justified. Next, we verify whether these 51 items can be sub-aggregated into goods or service groups. In testing the GCCT, we incorporate panel time-series analysis with cross-sectional dependence, unlike traditional GCCT tests with time-series data. We also conduct a nonparametric revealed preference test for weak separability as a benchmark against the GCCT test results. Our findings demonstrate that the utility function can be rationalized even when the data set is reclassified into 51 items, justifying the aggregation into service groups. This suggests that in the future, specifying the functional form of a service group can be developed into a traditional demand analysis, such as calculating estimates and elasticities.