An Engel Curve for Variety

Standard approaches to measuring the welfare gains from variety take variety as exogenous to consumers. Empirically we observe an Engel curve for variety, with richer consumers purchasing a larger set of varieties than poor ones. I present a tractable model for analyzing the welfare gains from variety in the presence of this non-homotheticity. The model generates variety Engel curves through diminishing marginal utility of quantity and variety transaction costs. Estimates of welfare gains that assume all variety differences across consumers are exogenous will be biased in the presence of variety Engel curves. Differences in relative prices and transaction costs for marginal varieties can shift variety Engel curves and change their slopes, affecting the distribution of gains from variety and the measurement of real (welfare) inequality. I use data on food consumption in India to implement the model and show that variety Engel curves have important empirical implications for measurement of the size and distribution of welfare gains from food variety. ∗I am grateful to Pierre-Olivier Gourinchas, Chang-Tai Hsieh, Ted Miguel, Yuriy Gorodnichenko, and Mu-Jeung Yang for valuable discussions and to participants of the Development and Macro/International Seminars and workshops at UC Berkeley. I gratefully acknowledge financial support from the Social Sciences and Humanities Research Council of Canada, the Institute for Business and Economics Research and the Center for Equitable Growth at UC Berkeley. All errors are my own. Comments welcome. [email protected] AN ENGEL CURVE FOR VARIETY 1