A fixed-basket, or fixed-weight, price index is essentially just that: it measures changes in the cost of purchasing a fixed basket of goods (and services). For the CPI, price quotes are collected monthly, selected to be representative of the various categories of consumer goods and services. 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. Viewed from the standpoint of an individual household, a COLI seeks to measure the percentage change in expenditures a household would have to make in order to hold constant some specified standard of living or level of material well-being.2 In an aggregate COLI, price and expenditure data must be combined to produce an estimate that reflects some measure of average change in the cost of living for all (or some subgroup of) households.
In recently reiterating its acceptance of a COLI as the measurement objective for the CPI, the BLS added a number of important cautions: “It [the COLI] is a theoretical concept based on the well-being of the individual consumer, so . . . additional assumptions about how to apply it as a measurement objective for an aggregated set of consumers . . . must be made” (Bureau of Labor Statistics, 1997b: 3). Further: “While the CPI may be described formally in the context of a cost-of-living index, there is no single all-purpose definition of the target.” The concept of the standard of living that is to be held constant in a cost-of-living index is far from unambiguous. Various analysts have offered different definitions of what universe it should cover (e.g., the standard of living obtainable from public and private goods or from private goods only), and embedding the concept in a regularly published statistical index raises thorny problems.
The discussion and controversy about the CPI reflect a large number of conceptual and measurement issues: As a guide for the BLS in making decisions about how the index should be designed and measured, what are the advantages and limitations of the concepts that underlie fixed-weight and cost-of-living indexes? For many years attention centered on the “substitution issue”: To what extent is it possible to incorporate into the index the tendency of households to shift their purchases toward those goods whose prices have risen the least or fallen the most? But there are other important questions of index design whose
See Chapter 2 for a discussion of standard of living in the context of cost-of-living theory. Briefly, consumers think more goods are better than less and can consistently rank alternative bundles of goods in terms of a set of preferences. Constrained by income and prices, each consumer chooses the most preferred bundle of goods. The consumer’s “standard of living” (or “material well-being”) is a measure of the extent to which preferences are satisfied.