reference period and a subsequent comparison period. The panel labels this a cost-of-goods index (COGI) (for convenience, we use the term “goods” throughout this report to denote goods and services, unless otherwise specified). In contrast, a cost-of-living index (COLI) measures the change in expenditures a household would have to make in order to maintain a given standard of living.
In 1997 BLS told Congress that it had been using the cost-of-living concept for many years as a framework for making decisions about the CPI and that it accepts the COLI as the measurement objective for the index. Recognizing the many theoretical and measurement issues involved in embodying a cost-of-living concept in an index, BLS asked the Committee on National Statistics of the National Academies to convene a panel of experts “to investigate conceptual, measurement, and other statistical issues in the development of cost-of-living indexes.”
For dealing with many of the issues considered in this report, there are close parallels between the COGI and COLI approaches. Nevertheless, having a clear conceptual basis for the index is important. It serves as an authority that can be appealed to when making difficult choices among alternative procedures or for accommodating the new developments constantly being generated by a technologically innovative economy.
The cost-of-living approach provides a rationale for taking account of the fact that, when prices change, consumers do not continue to purchase the same fixed basket, but shift their purchases toward goods whose relative prices have fallen. The concept of the COLI explicitly takes into account the effect of this substitution behavior in reducing the expenditure required by a consumer to maintain a given standard of living when prices change.
Probably the single most difficult and important task in index construction is dealing with the ongoing flow of quality changes among consumer goods and services. Many economists consider the economic theory underlying the COLI a helpful way of initially approaching the problem because it prompts the question: “What are the particular attributes of goods that consumers value?” This may provide a way to start, but the panel found that, beyond this point, current techniques for addressing problems associated with changing item quality can be analyzed with minimal use of the theory underlying the COLI and that the techniques could be applied within either a COGI or a COLI framework.
While a COLI framework offers some conceptual advantages, giving up the relative simplicity of the COGI comes at a cost. Conditions that complicate the estimation and cloud the interpretation of COLIs—such as changes in consumer tastes or changes in buying patterns caused by changes in income—may be present in practice. A CPI constructed on cost-of-living principles can, therefore, only be an approximation to the COLI that it seeks to measure. Moreover, re-