The Unequal Gains from Product Innovations

Abstract

Using detailed product-level data in the retail sector in the United States from 2004 to 2013, I find that product innovations disproportionately benefited high-income households due to the endogenous response of supply to shifts in demand, which amplified inequality. My analysis consists of two parts. In the measurement part, I show that annual quality-adjusted inflation was 0.66 percentage points lower for high-income households, relative to low-income households. This gap resulted from both lower inflation on continuing products and a faster increase in product variety for the high income. In the mechanism part, I use national and local changes in demand that are plausibly exogenous to supply factors - from shifts in the national income and age distributions over time, and from food stamp policy changes across states - to provide causal evidence that a shock to the relative demand for goods (1) affects the direction of product innovations, and (2) leads to a decrease in the relative price of the goods for which demand became relatively larger (i.e. the long-term supply curve is downward sloping). Calibrations show that this channel explains most of the observed difference in quality-adjusted inflation rates across income groups. I find support for the external validity of these findings by using more aggregate data on the full consumption basket of American households back to 1953.