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

Several cross country studies find that rising household income leads to consumption spending being spread more evenly across different spending categories (Clements et al., 2006). We argue that this result is likely due to aggregation. Using more disaggregated UK household level spending data, we show that the spending diversity of households only rises up to a certain income level and then starts to decline as households concentrate more of their spending on particular expenditure categories that differ across households. It is precisely because of this growing heterogeneity of spending patterns on the household level that the average spending diversity of the population can nevertheless always rise in income. We build a model to capture these observed patterns and use it to show that ignoring preference heterogeneity across households and focusing on a model with representative households leads to an underestimation of the value of product variety.