Revisiting the Income Effect: Gasoline Prices and Grocery Purchases

Abstract

This paper examines the importance of income effects in purchase decisions for everyday products by analyzing the effect of gasoline prices on grocery expenditures. Using detailed scanner data from a large grocery chain as well as data from the Consumer Expenditure Survey (CES), we show that consumers re-allocate their expenditures across and within food-consumption categories in order to offset necessary increases in gasoline expenditures when gasoline prices rise. We show that gasoline expenditures rise one-forone with gasoline prices, consumers substitute away from food-away-from-home and towards groceries in order to partially offset their increased expenditures on gasoline, and that within grocery category, consumers substitute away from regular shelf-price products and towards promotional items in order to save money on overall grocery expenditures. On average, consumers are able to decrease the net price paid per grocery item by 5-11% in response to a 100% increase in gasoline prices. We find evidence that this consumer substitution effect happens given retail price adjustments due to passthough of higher gasoline prices into retail prices, by investigating two price indexes; one that uses shelf-prices and one that uses prices net of promotional discounts (net-prices are equal to shelf-prices if there is no discount). We assess the effect of gasoline prices on each of the price indexes, controlling for store-level fixed-effects and regional time trends, finding a 5 percent increase in net prices as a result of a 100 percent increase in gasoline prices. Product prices appear to adjust flexibly with gasoline prices through the size of discounts and promotions, which change weekly (or by-weekly) even though shelf-prices remain stable. Our results show that consumers respond to permanent changes in income from gasoline prices by substituting towards lower-cost food at the grocery store and lower priced items within grocery category. The substitution away from full-priced items towards sale items has implications for microeconomic demand models as well as for macroeconomic inflation measures that typically do not incorporate frequently changing promotional prices. IntroductionThe extent to which relatively small income shocks change consumer purchase behavior has significant implications for our understanding of business cycles, fiscal policy and the macro economy. For example, some argue that increases in oil prices may lead to recessions through an income effect on overall consumption (Hamilton, 1983). 1 If spikes in gasoline prices significantly decrease disposable income, and if consumers react by curbing expenditures in other categories, then oil prices may have a significant impact on the macro-economy through their effect on consumption. Several recent studies present empirical evidence that households do not smooth consumption over income fluctuations, but instead adjust current consumption to changes in current income more than would be expected under the Permanent Income Hypothesis (Poterba,...

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