At What Price? Conceptualizing and Measuring Cost-of-Living and Price Indexes (2002) / Chapter Skim
Currently Skimming:
1 Introduction
1 Introduction
Pages 13-37
The Chapter Skim interface presents what we've algorithmically identified as the most significant single chunk of text within every page in the chapter.
Select key terms on the right to highlight them within pages of the chapter.
From page 13... ...
Several decades ago the CPI was widely used in labor contracts to index wages, with the goal of providing automatic adjustments to keep wages fully or partially current with changes in the cost of living. With the same goal in mind protection against changes in the cost of living the Congress determined in 1972 that the CPI should be used to make annual "cost-of-living adjustments" to social security benefits, and the practice was subsequently extended to many other public transfer payments.
|
From page 14... ...
Concerns have long been expressed that the CPI does not adequately take account of improvements in the quality of consumer goods and services in a technologically dynamic economy and thereby overstates the price increases consumers are paying for goods of constant quality. As a consequence, indexing wages, social security benefits, or other payments scaled to the CPI would usually overstate the amount needed to compensate for increases in the cost of living.
|
From page 15... ...
The observed price changes are assigned weights, representing the importance of each category in aggregate consumer expenditures during some base period, then combined into the major CPI subcomponents, such as food, shelter, appliances, and so forth and, subsequently, into an overall national average. A COLI is more ambitious and correspondingly more difficult to produce in that its objective is to measure changes in living costs.
|
From page 16... ...
3Unless otherwise specified, ``goods,, refers to both goods and services throughout the report. Technically, the index measures the ratio of the expenditures needed in the current period to purchase the same basket of goods as in the base period; the percentage change is simply that ratio minus 1.0 (times 100)
|
From page 17... ...
The panel specifically considers what, if anything, BLS could do to identify and estimate quality and pure price components of differences in the observed prices of goods across outlets. Chapter 6 examines conceptual and measurement issues pertaining to the construction of the complicated medical services component of the CPI.
|
From page 18... ...
For example, in a modern innovative economy, even over a relatively short period of time, the characteristics of a wide range of goods and services are constantly changing. When consumers pay more for a new model of a good, how much of that represents a true price increase and how much a payment for higher quality?
|
From page 19... ...
However, since individuals have differing (marginal) evaluations of quality, the conceptual framework for deriving overall quality adjustments from observed differences in market prices raises some difficult issues that have not been fully worked through by the BLS or by academic researchers.
|
From page 20... ...
With a very broad definition of what should be included in its domain, a COLI would be adjusted up or down to take account of the positive or negative effects on consumer well-being arising from a wide range of sources outside the marketplace that have not traditionally been considered relevant for inclusion in the CPI. These include, among other elements, the quality of the air, water, and other environmental amenities; the presence or absence of congestion on roads and in neighborhoods; changes in perceptions about personal security associated with trends in the crime rate; the effects of significant climate changes; and increases in longevity arising from broad environmental factors (aside from those associated with specific medical procedures)
|
From page 21... ...
periods by the quantities purchased in the reference period. Considered from the standpoint of an individual household, such an index reflects the percentage increase in expenditures the household would have to incur in order to buy the reference period basket of goods at the new, comparison period prices.7 But when faced with Technically, the index is the ratio of the comparison period to the base period expenditures, but the percentage change is simply that ratio minus 1.0 (times 100)
|
From page 22... ...
Equivalently, the Paasche index understates the change in the household's cost of living, as evaluated at the comparison period's standard of living. If substitution behavior plays a major role in explaining changes in quantities purchased between the reference and comparison periods, goods that have experienced relatively large price increases will tend to receive higher weights in the Laspeyres than in the Paasche index, and the opposite will be true for goods that have experienced relative price decreases.
|
From page 23... ...
He labeled such measures superlative indexes. The Fisher ideal index is one of many possible formulations of a superlative index, all of which involve some form of averaging base period and comparison period weights.
|
From page 24... ...
As a consequence, the superlative indexes that BLS will publish will apply to the period 2 years earlier: the index published in 2002 will measure price changes only through 2000. Recent research studies (e.g., Aizcorbe and Jackman, 1993, and Shapiro and Wilcox, 1997)
|
From page 25... ...
However, the theoretical work that demonstrates that a superlative can provide a close approximation to a measure of the change in the reference period cost of living assumes that changes in purchase patterns stem solely from substitution behavior by households with stable tastes or preferences. To the extent that changes in tastes rather than substitution behavior causes purchase patterns to shift, a superlative index will lose some of its accuracy as a measure of the cost of maintaining the reference period level of living.
|
From page 26... ...
The first of these is peculiar to a COLI and the other two are common to both a COGI and a COLI. First, from the standpoint of measuring consumer substitution behavior, different groups may be more or less inclined to switch their expenditure patterns in the face of changes in relative prices.
|
From page 27... ...
The most frequent criticism of the CPI in recent years, typified by the Boskin commission report, has been that it significantly underestimates the extent of quality improvement in goods and services and therefore overstates the rate of inflation. For many decades, the BLS had been aware of problems posed by goods and services whose quality changed over time and had cautiously extended its use of explicit quality adjustments.
|
From page 28... ...
But, as producers of official statistics, the BLS must walk a difficult line: It must seek to develop and apply techniques for measuring quality change, but it also has to recognize that there are substantial conceptual, statistical, and data availability problems to be solved before it can produce careful and replicable estimates that will be widely accepted. The adjustment of observed price changes, to eliminate those that reflect changes in the quality of the goods purchased, raises conceptual and measurement issues.
|
From page 29... ...
The large volume of items that are implicitly adjusted each year for quality change suggests the potentially high value of research directed toward developing reliable methods for widening the applicability of explicit quality adjustment techniques. The rapid growth of research in hedonic techniques (coupled with the lack of research on alternatives)
|
From page 30... ...
In Chapter 4 the panel considers in detail the proper balance between the pursuit of improved and expanded direct quality measurement and a rigorous program of selection, testing, and experimentation before implementation. Medical Care Pricing medical care embodies the most difficult quality-related problems associated with constructing a cost-of-living index, and the panel gives it special attention.
|
From page 31... ...
First, many of those who advocate a cost-of-living approach to index construction argue that the consumption welfare effects that accompany the appearance of a new good are missed. Under traditional procedures, new goods, both those that enter through item rotation or after item reclassification, are linked into the CPI in such a way that their introduction, in itself, has no effect on the level of the index.
|
From page 32... ...
To the extent that new goods are disproportionately purchased by the affluent in the early stages of a product's cycle, distributional consequences will arise as these goods are brought into the index. If the relative prices of new goods fall, the growth of the overall index will, on this account at least, tend to understate the inflation faced by low- and middle-income consumers.
|
From page 33... ...
The BLS gradually rotates the sample of retail outlets from which it collects prices, and over time the new samples capture the changing mix of outlets patronized by the buying public. Under current BLS procedures, when new stores enter the sample, all of the difference between an item's price at the old outlet and its price at the new outlet is implicitly assumed to reflect differences in the "quality" of the shopping experience; none of it shows up as a pure price change.
|
From page 34... ...
An alternative method of estimating the cost of housing services, and the one currently used by the BLS, is to try to find a sample of rental housing that is equivalent in quality to owner-occupied housing and use the change in rents within that sample as a measure of changes in the cost of owner-occupied shelter services. This method also poses measurement difficulties of various kinds, including the difficulty of finding, in each geographical area for which the BLS collects prices, a representative sample of rental housing that is truly equivalent to owner-occupied housing.
|
From page 35... ...
In fact, considering its range of applications, it is probably rare when the CPI does measure exactly what is needed. The CPI is currently used in many ways, including: · as a compensation measure to calculate how much is needed to reimburse recipients of social security and other public transfer payments for changes in the cost of living, and for formal or informal use in wage setting; · for inflation indexation in private contracts; .
|
From page 36... ...
Where relevant, we spell out the public policy consequences of using alternative index designs for making cost-of-living adjustments in public transfer programs, indexing the tax system, and for other purposes. And while we make no recommendations on the subject, we explore the public policy implications of using a wage instead of a price index for escalating social security and other benefits.
|
From page 37... ...
Given that there is some functional overlap between the CEX and POPS, the panel considers, among other things, the possibility of merging or better coordinating these two surveys. The report also reviews the CPI's Commodities and Services Survey, a longitudinal survey that tracks changes in price quotes for most CPI sampled consumer items over time.
|
Key Terms
This material may be derived from roughly machine-read images, and so is provided only to facilitate research.
More
information on Chapter Skim is available.