On the Welfare Cost of Consumption Fluctuations in the Presence of Memorable Goods

Rong Hai, Dirk Krueger, Andrew Postlewaite
2013 Social Science Research Network  
We propose a new category of consumption goods, memorable goods, that generate a flow of utility after consumption. We analyze an otherwise standard consumption model that distinguishes memorable goods from other nondurable goods. Consumers optimally choose lumpy consumption of memorable goods. We empirically document differences between levels and volatilities of memorable and other goods expenditures. Memorable goods expenditures are about twice durable goods expenditures and half the
more » ... nd half the volatility. The welfare cost of consumption fluctuations driven by income shocks are overstated if memorable goods are not accounted for and estimates of excess sensitivity of consumption might be due to memorable goods. We can entertain ourselves with memories of past pleasures .. . (Adam Smith [1759]) Much of the pleasure and pain we experience in daily life arises not from direct experience -that is, "consumption" -but from contemplation of our own past or future or from a comparison of the present against the past or future. The fact that experiences are carried forward in time through memory enables them to affect welfare at later times. (Loewenstein and Elster [1992] ) In this paper we propose to augment the canonical distinction of consumption goods into nondurable and durable goods by a third category which we call memorable goods. Conceptually, a good is memorable if a consumer draws utility from her past consumption experience, that is, through memory. A dinner at a three star restaurant on your anniversary will be enjoyed for months, and possibly years, afterward. 1 In addition to generating immediate utility, the meal contributes to a stock of memories that may depreciate over time but generate utility in the meantime. Based on this idea we construct a novel consumption-savings model of nondurable and memorable goods. As in the example, memorable goods consumption impacts future utility through the accumulation of the stock of memory. We demonstrate that in the model households optimally choose a non-smooth consumption profile of memorable goods and that delaying current memorable goods consumption may increase life-time utility. Our model predicts that in the presence of a negative income shock households optimally postpone their memorable goods consumption and reduce the size of memorable goods expenditure spikes. Finally, we show that these expenditure patterns have important consequences for two applied questions: the welfare losses from consumption fluctuations and the excess sensitivity of consumption to expected tax rebates. In terms of its defining characteristics a good is memorable (as opposed to durable) if, even though it is not physically present anymore, the consumer derives utility from its past consumption. 2 In order to make the concept of a memorable good empirically operational, we utilize observed purchase and consumption patterns. Traditionally, consumption goods are differentiated only according to whether or not they have a physically durable component. For a nondurable consumption good, expenditures on the good and the physical, utility-generating consumption act typically occur frequently and coincide. After the act of consumption the good is physically fully depreciated. Durable goods are typically purchased infrequently, but their utility-yielding continuous service flow lasts as long as the durable good is physically present. In contrast, the defining characteristic of a memorable good is that it can potentially create a flow of utility from the memory generated by some consumption paths. A property of a memorable good (as implied by consumers' optimal choices) is that there is often infrequent expenditure and infrequent physical consumption of 1 Work in psychology and marketing finds evidence of utility from memories. Using fMRI Speer et al. (2014) show that the same neural circuitry that responds to monetary rewards is stimulated by positive memories. They also find that participants were willing to sacrifice monetary rewards to activate positive memories. Zauberman et al. (2009) find a connection between recall of positive memories and responses to monetary rewards; participants were willing to sacrifice more tangible rewards in order to activate positive memories: "When people make decisions about experiences to consume over time, they treat their memories of previous experiences as assets to be protected." 2 Since memorable goods are not physically present anymore after their consumption they also cannot serve as collateral. Thus, and in stark contrast to durable goods, memorable goods may be harder to purchase on credit.
doi:10.2139/ssrn.2322749 fatcat:psfu4zfd3fbypkachkaxaqu7ou