Price Search, Consumption Inequality, and Expenditure Inequality over the Life Cycle

In this paper, we incorporate a price search decision into an incomplete markets model and differentiate consumption from expenditure. In our model, consumers are allowed to allocate part of their time on searching for low prices which leads to an endogenous price dispersion. A plausibly calibrated version of the model predicts that the cross-sectional variance of consumption is, on average, 15% smaller than the cross-sectional variance of expenditure throughout the life cycle. Price search has an alternative productive activity role and provides a partial insurance mechanism against bad income shocks. We also discuss some policy implications.