PRICE SEARCH, CONSUMPTION INEQUALITY AND EXPENDITURE INEQUALITY OVER THE LIFE ‐CYCLE

Abstract We differentiate consumption from expenditure by incorporating price search decision into an otherwise standard life‐cycle model. We first analytically show that, under very general conditions, poorer households search more and pay lower prices compared to wealthier ones. As a result, consumption inequality is smaller than expenditure inequality, and the gap between them increases over the life‐cycle. Next, using a plausibly calibrated model, we find that life‐cycle increase in consumption inequality is about 30% lower than the increase in expenditure inequality. Price search provides an insurance mechanism against income shocks and increases the welfare of a newborn by 3.9%.