Household spending diversity, aggregation, and the value of product variety

Abstract

This paper studies the diversity of household consumption spending, i.e. how widely households distribute their spending across different types of goods. Using detailed UK expenditure data (1990–2015), we show that the diversity of household spending rises in income up to a certain level and then declines as richer households increasingly concentrate their spending on specific expenditure categories. As these categories differ across households, spending diversity on the aggregate level can keep rising in income while spending diversity on the household level falls. We build a model with heterogeneous nonhomothetic preferences that can explain the observed patterns, highlighting the role of aggregation. Our model shows that ignoring preference heterogeneity and assuming representative households leads to a (potentially very large) underestimation of the value of product variety. Estimating the welfare effects of trade or innovation policies therefore requires to appropriately account for the empirically observed heterogeneity and nonhomotheticity of preferences.