121 Pages Posted: 30 Dec 2015 Last revised: 26 Dec 2016

Date Written: December 26, 2016

Abstract

Using detailed barcode-level data in the US retail sector, I find that from 2004 to 2013 higher-income households systematically experienced a larger increase in product variety and a lower inflation rate for continuing products. Annual inflation was 0.65 percentage points lower for households earning above $100,000 a year, relative to households making less than $30,000 a year. I explain this finding by the equilibrium response of firms to market size effects: (A) the relative demand for products consumed by high-income households increased because of growth and rising inequality; (B) in response, firms introduced more new products catering to such households; (C) as a result, continuing products in these market segments lowered their price due to increased competitive pressure. I use changes in demand plausibly exogenous to supply factors — from shifts in the national income and age distributions over time — to provide causal evidence that increasing relative demand leads to more new products and lower inflation for continuing products, implying that the long-term supply curve is downward-sloping. Based on this channel, I develop a model predicting a secular trend of faster-increasing product variety and lower inflation for higher-income households, which I test and validate using Consumer Price Index and Consumer Expenditure Survey data on the full consumption basket going back to 1953.