Economists have always been interested in understanding the link between household consumption and savings. New research analyzes how people substitute time for money.
Conventional wisdom says that those who spend more also consume more. But what if some consumers are simply paying more for the same item?
In the study "Lifecycle Prices and Production," University of Chicago Graduate School of Business professor Erik Hurst and coauthor Mark Aguiar of the Federal Reserve Bank of Boston find that households who shop more intensively pay lower prices for identical goods.
"We outline a new way to think about the issue of household consumption and savings decisions," says Hurst. "Our objective was to understand how and why individuals pay different prices for the same product."
Hurst and Aguiar find substantial differences in the prices paid for identical goods in the same metropolitan area at a given point in time. Middle-aged, wealthy, and large households pay the highest prices for identical goods, with middle-aged consumers paying approximately 5 percent more for a given product than older households.
In addition, Hurst and Aguiar find that people who shop twice as often pay approximately 10 percent less for a given product.
After analyzing demographic data, the authors measured how much people were willing to trade time for money. Once the authors were able to measure the relationship between time spent on shopping and how much money an individual could save by shopping more, they could calculate the individual's "opportunity cost of time."
"The opportunity cost of time is usually measured by wage," explains Hurst. "If you take an hour that could be spent working and devote that hour to another activity, you give up potential income. Opportunity cost is not always directly related to wages though; that hour could be spent attending your child's soccer game or cooking dinner."
Hurst and Aguiar find that the opportunity cost of time for an individual at middle-age is approximately 40 percent higher than for retirees. In terms of demographics, the people who pay the lowest prices for a given item are those who have the lowest opportunity cost of time: the elderly, the young, the less educated, and those with low incomes.
The authors argue that it is important to understand household consumption behavior because the quantity of goods consumed or total consumer spending do not tell the full story about economic well being. People with lower opportunity cost of time will pay lower prices for the same products.
"Your wage tends to be highest in your 40s, so it's not worth your time to clip coupons," says Hurst. "Second, perhaps you prefer attending your child's soccer game to shopping. As people get older, the value of their time goes down because their wages go down and they are less constrained by the demands of raising children. Having more time to shop results in paying lower prices."
Spending, Consumption, and Theory
Households alter their relationship between spending and consumption in a way that is consistent with standard economic principles.
Hurst and Aguiar's study is rooted in two seminal economic studies from the 1960s, including a landmark study by Nobel laureate Gary Becker. Becker, University Professor of Economics and of Sociology at the University of Chicago Graduate School of Business and the University of Chicago, argued that individuals will allocate their time where it has the highest payoff. If the value of one's time is low, that person will work less than if the value of their time is high.
"For example, if I only earn a penny an hour, I won't be giving up much money if I stay home and watch television," says Hurst. "However, if I earn hundreds of dollars per hour, it would be very expensive for me to stay home and watch television."
Hurst and Aguiar took Becker's model and applied it to shopping behavior using new data sets. When the opportunity cost of time is low, people will spend more time searching for bargains, and as a result, will spend less for the same product. If the opportunity cost of time is high, people are unlikely to search several stores to find the lowest price.
Hurst and Aguiar combined Becker's model with the lifecycle consumption model developed by Nobel laureate Milton Friedman, Paul Snowden Russell Distinguished Service Professor Emeritus in Economics at the University of Chicago. According to Friedman, people smooth consumption over their lifetime to increase well being.
Hurst and Aguiar's data also suggests that people do smooth their consumption over time, but not necessarily their expenditures. They find that expenditures fluctuate solely based on changes in price without changes in actual consumption.
"Middle-aged people have the highest wages and highest demands on their time. As a result, they pay higher prices," says Hurst. "If you are comparing spending across ages, it is important to recognize that part of the differences in spending patterns is due to differences in prices paid."
Time and Money
The authors used data from ACNeilsen's Homescan Panel, which collects grocery package goods scanner data at the household level. Each purchase in the database records the actual price paid by the household according to UPC bar codes. The Homescan Panel has detailed demographic information, including age, sex, race, family composition, education, employment status, and household income, and tracks household purchases across multiple retail outlets.
Hurst and Aguiar used data for the city of Denver from January 1993 to March 1995. The ACNeilsen database includes information about shoppers, purchase date, the store, and the total amounts spent due to promotions, sales, and coupons. Using store and date information, ACNeilsen can link each product scanned by the household to the actual price it was selling for at the retail establishment. The authors focused on shoppers aged 24 to 75, with more than 2,000 households in the sample.
Using data from the 2003 American Time Use Survey conducted by the U.S. Bureau of Labor Statistics, the authors defined two measures of "home production:" 1) the total time spent on food production (preparing meals and cleaning up); and 2) total home production (food production, indoor cleaning and chores, clothes care, outdoor maintenance, lawn care). The authors added another category to home production, shopping.
Time spent on home production peaks for households in their early 40s and then again for households over age 65.
Economic theory suggests that, all else being equal, households with lower opportunity costs of time likely will spend more time shopping to reduce the prices they pay for a given product. For example, shoppers can go to multiple stores to take advantage of sales, shop at superstores which may require longer commutes, clip coupons, or mail in rebates.
Using the Homescan data, the authors tested their basic premise that households with lower opportunity cost pay lower prices for identical goods and find that the price paid for a particular item depends on income. Specifically, households with an annual income of more than $70,000 on average pay 5 percent more for an identical item (defined by UPC code) than households earning less than $30,000.
Another influence on the opportunity cost of time is the large time demand associated with raising children. Households with more children pay higher prices for identical items than households with fewer or no children.
Using the 2000 census, the authors find that the number of children in married households peaks when the head of the household is in his or her early 40s. The wages of both men and women peak between the ages of 45 and 50. Profiles of children and market wages suggest that the opportunity cost of time is greatest in middle age.
Hurst and Aguiar find that households with only one member pay 10 percent less for an item compared to families with at least five people. Single females with no children pay 7 percent lower prices than married couples with children. Single males with no children pay 4 percent lower prices than married couples with children.
Households in their early 40s pay an average of 6 to 8 percent more for identical goods than households in their early 20s or in their late 60s.
Busy, middle-age shoppers purchase goods at whatever price prevails on the date they shop, sometimes finding sales but often finding high prices. Households in their mid-40s have the largest family sizes, and as a result, the greatest shopping needs. Households in their post-retirement years have the lowest opportunity cost of time and therefore shop more intensively. Young households shop relatively little because they buy relatively few goods and have work and education demands on their time.
Hurst explains that it is not only comparison shopping that produces lower prices; people may also buy different goods. "I might buy takeout food, which is faster, while you might buy raw ingredients to cook your meal, which is cheaper," says Hurst. "Choosing between those two options changes over the lifecycle."
Hurst and Aguiar find that expenditure rises rapidly early in the adult lifecycle (peaking around age 40), declines until late middle age, then rises through retirement. Given that family size is largest for households around age 40, it is not surprising that household expenditure is largest in middle age.
Are Baby Boomers Prepared for Retirement?
There are numerous applications for research about household consumption and savings. Insights from modeling household production have already proved fruitful in explaining phenomena from baby booms to business cycles.
"Once we have a model that predicts consumer behavior, we can see how people respond to Social Security reform, tax changes, unemployment shocks, and business cycles," says Hurst.
A current topic of concern has been Social Security reform and whether the baby boom generation is prepared for retirement. Hurst suggests that decisions about cutting or raising benefits for public and private pensions depend on understanding current patterns of household consumption.
"Previous research has suggested that at the time of retirement, household expenditures fall sharply, which has led some to conclude that people aren't financially prepared for retirement," says Hurst." Our paper suggests that the current system is working. Just because retirees" expenditure is falling doesn't mean they are consuming less; we show they are just paying lower prices for the same consumption goods."
Erik Hurst is professor of economics and Neubauer Family Faculty Fellow at the University of Chicago Graduate School of Business.