At What Price? Conceptualizing and Measuring Cost-of-Living and Price Indexes (2002) / Chapter Skim
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8 Whose Index? Aggregating Across Households
8 Whose Index? Aggregating Across Households
Pages 222-251
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From page 222... ...
Even with many subgroup indexes, there is still enough heterogeneity within those subgroups that the averaging issue would still have to be faced. As noted throughout this report, the Consumer Price Index (CPI)
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From page 223... ...
Such questions arise in much the same form whether one is working with fixed-basket or cost-of-living indexes. This chapter pays particular attention to the fact that the data collection system underlying the CPI, and those employed to produce price indexes in other countries, cannot now provide important elements of the information needed to explore consequences of consumer heterogeneity and, specifically, to determine whether inflation rates do in fact differ among various groups within the population.
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From page 224... ...
It is also quite possible that the ability or willingness of an individual to substitute in response to changes in relative prices differs depending on the level of that individual's income. In consequence, the magnitude of the substitution effect built into a cost-of-living index (COLI)
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From page 225... ...
Some observers point out that quality improvements and technological advances, which present one of the most difficult issues in price index calculation, are more prevalent among the types of goods purchased by rich than by poor households and that the rich are the first to acquire such goods. As a consequence, an overall price index corrected for quality change runs the risk of understating inflation for the poor, even if it accurately incorporates the effect of quality change for those who can afford to buy new and improved goods.
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From page 226... ...
GROUP INDEXES: WHY THE CURRENT DATA COLLECTION SYSTEM CANNOT PRODUCE THEM Chapter 1 describes how BLS produces the CPI in two stages. At the first stage, known as the lower level, BLS collects data on monthly price changes for individual items not from individual households, but from a sample of retail outlets throughout the nation.
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From page 227... ...
In this process, all within-stratum heterogeneity is lost.2 And since the price changes are collected from retail stores, there is no way to assemble the data so as to make a direct link between the particular price, quality, and brand of items purchased and the economic or demographic characteristics of those who purchased them.3 At the second or upper-level stage of estimation an overall CPI is calculated as an average of the 218 stratum indexes, with each index assigned a weight equal to the proportion of total consumer expenditures devoted to purchases of the goods in that stratum, estimated from the Consumer Expenditure Survey (CEX)
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From page 228... ...
And we do not know because we do not have prices that are collected for items that are purchased by the elderly." The Boskin commission (Boskin et al., 1996:72) , in its discussion of a separate price index for the elderly, points out that an index for the elderly calculated by using CPI prices and reweighting to match the expenditure patterns of the elderly does not differ substantially from the index for the non-elderly but recognizes that "the prices actually paid, not just expenditure shares, may differ." Actually, for the period December 1990 to December 1995, the experimental CPI-E rose by 15.9 percent, somewhat more than the CPIU and CPI-W, which rose by 14.7 and 14.1 percent, respectively (see www.bls.
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From page 229... ...
In a footnote at the beginning of its report, the Boskin commission wrote (Boskin et al., 1996:5~: "In principle, if not in practice, a separate cost of living index could be developed for each and every household based on their actual consumption basket and prices paid." Those individual indexes could be combined or averaged into many possible combinations a single national average for all households and separate indexes for various population subgroups and geographic areas. To produce an overall national index, the indexes for the individual households could be averaged, giving equal importance to each (a democratic index)
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From page 230... ...
to calculate an index that measures the rate of inflation or the rise in the cost of living that the household has experienced. An Alternative Approach A less ambitious but more feasible approach to the aggregation problem would be to exploit the fact that an important part of the heterogeneity among households in consumption patterns and prices paid is systematically related to differences in their economic and demographic characteristics and in their geographic location.
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From page 231... ...
and combined to give equal importance to each income so as to approximate a democratic index. And, of course, if individual group indexes, say for the elderly or the poor, frequently moved differently from an overall national index, they could be used for indexing public transfer payments going to those groups.
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From page 232... ...
HOW MIGHT DATA FOR SUBGROUP INDEXES BE ASSEMBLED AND WHAT WOULD IT COST? Currently, data on prices are collected by BLS in a separate operation from the survey that yields the expenditure patterns used to provide the weights for combining strata indexes into the overall CPI.
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From page 233... ...
that would be required. The size of a monthly panel survey needed to collect price data from individual households that could be crossclassified simply by income, age, and region would be unprecedented.
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From page 234... ...
While the resulting subgroup indexes of strata prices would reflect the specific kinds and qualities of items purchased and the specific outlets patronized by each subgroup, this data collection system would be unable to take into account differences which might exist among subgroups if they differ in the extent to which they concentrate their purchases at times and in outlets where sales occur. The presence or absence of this kind of shopping behavior may or may not turn out to be an important factor affecting the average prices paid by one group relative to another.
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From page 235... ...
But documenting in some depth the existence of substantial differences in prices paid, systematically related to income and other demoWithin each population subgroup the aggregation of individual item prices into strata indexes would be done with "plutocratic" expenditure weights, but in each subgroup the strata indexes could be aggregated into a subgroup average with democratic weights, and in turn the overall CPI could be aggregated from the subgroup indexes with democratic weights.
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From page 236... ...
Either as a separate survey or as part of the regular diary survey within the CEX, several panels of households drawn from different income groups could be furnished with handheld computers and asked to record, over a period of some months, the prices, quantities, and product codes of items they purchased. This experiment could shed light on several important questions, such as how reliably product identification can be reported and, for particular strata, what sample size would be needed to generate a sufficiently large set of matched price quotes each month.
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From page 237... ...
PLUTOCRATIC VERSUS DEMOCRATIC WEIGHTS As we have described, the sample selection technique used by the BLS, at the lower-level stage of constructing the CPI, implicitly assigns to every price change within a commodity stratum a weight that is proportionate to total consumer expenditures on that item in the base period. It averages these weighted individual price changes to produce a separate price index for each stratum.
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From page 238... ...
But it would not be a full democratic index, because at the lower level of index construction the individual item prices would not be linked with the income levels of the households who purchased them and would continue to be combined into strata indexes using weights proportional to total expenditures for those items by all consumers. To look at it another way, the stratum prices indexes would be the same for everyone, while the budget shares 13For technical reasons, the individual strata within which expenditure data are collected in the diary survey have to be collapsed into fewer categories than the overall CPI, which has 218.
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From page 239... ...
As would be expected, deviations from the change in the overall democratic index during these intervals were almost always a good bit smaller among the middle three quintiles than in the top and bottom ones. While they lasted, the differences in the change between the upper- and lower-quintile indexes were quite large, especially since the indexes captured only the difference in budget shares and not any differences in prices paid.
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From page 240... ...
We suspect it would not be very expensive to produce quintile indexes on a regular basis annually, if not monthly which might prove to be very useful for public policy purposes and would alert us when significant differences reappear. And while the overall quasi-democratic CPI did not depart in any substantial way from the regular plutocratic CPI, the same process that produces the quintile indexes would provide an ongoing quasi-democratic index that would indicate if differences did emerge.
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From page 241... ...
A first objective might be the production of indexes for a few commodity categories and several demographic groups. TECHNICAL NOTE 1: AGGREGATION AND THE "REPRESENTATIVE CONSUMER" The concept of the "representative consumer" frequently comes up in discussions of COLIs and of price indexes more generally.
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From page 242... ...
Neither of these constructions involves representative consumers of any sort, and neither is very difficult to understand, certainly not the former. Nevertheless, the idea of a representative agent is often appealed to, though we have tried hard to avoid it in this report.
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From page 243... ...
Second, if the conditions are satisfied, and one computes a COLI for a representative agent, what relationship does this COLI bear to the COLIs of the underlying consumers? Conditions for the Existence of a Representative Consumer We begin with a definition.
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From page 244... ...
Even though the representative consumer's purchases of each good is a simple average of individual purchases, the representative agent's COLI is not the simple average of the individual COLIs. Consequently, the use of a representative consumer framework in the context of plutocratic weights assigns more importance in the overall index to changes in the cost of living facing the rich than to those facing the poor.
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From page 245... ...
However, it is unclear whether the additional complexity of these formulations would commend them to those seeking straightforward interpretations of the COLI concept of a price index. Technical Derivation of the Representative Agent COLI Unless we place restrictions on the distribution of income, the existence of a representative agent requires that individual h has preferences that can be represented by cost functions of the Gorman "polar form" (Gorman, 1959~: c (u , p)
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From page 246... ...
BLS produces an experimental index for the elderly as a means to assess the validity of using the CPI-W to index social security benefits.l7 Attention has also been given to separate indexes for the poor and, more generally, to price index variation by income group. Empirical studies of the income-price inflation relationship often bear, at least indirectly, on the closely related issue of plutocratic versus democratic indexes discussed above.
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From page 247... ...
The Census Bureau poverty thresholds and the Department of Health and Human Services poverty guidelines, food stamp programs, low-income housing, and home energy assistance programs are all adjusted using the CPI-U. However, because the CPI is plutocratic, the representative household is upper middle class, which means that price changes as captured by the CPI are potentially very different than price changes faced by "average" low-income households.
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From page 248... ...
The balance of the evidence, then, points to either modest or no variation in inflation rates faced by different income groups, particularly for more recent periods. Consumption patterns specifically the relative weights of necessity versus luxury items may be different, but the differences do not translate into consistently bifurcated subindex growth rates.
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From page 249... ...
Also, the CPI for medical care, a comparatively important component of elderly expenditures, has increased more rapidly that has the overall CPI in recent years; however, measuring medical care costs is extremely complicated and it is hard to assess the accuracy of this CPI component. The most systematic evidence on inflation faced by the elderly has evolved from a 1987 congressional directive to BLS to develop an experimental index for the population over age 62.
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From page 250... ...
However, as Amble and Stewart (1994:141) report: "The experimental price index for older consumers is a weighted average of price changes for the same set of item strata and [is]
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. The method entails comparing Laspeyres indexes, which assume no substitution bias, with Paasche indexes, which weight item categories using the most recent period's consumption and probably overstate substitution.
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