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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
bined into an overall CPI with weights derived from the Consumer Expenditure Survey (CEX), reflecting consumption patterns in the base period (currently 1993-1995). This second stage in the process is referred to as upper-level aggregation.
How BLS Deals with Substitution in the CPI
If the goods within a stratum are similar in terms of meeting a particular consumer demand (a characteristic of most but by no means all strata), consumer substitution among individual products is clearly important—for example, Golden Delicious substituted for Gala apples. Beginning in 1999, the BLS replaced arithmetic with geometric averaging (“geomeans”) to combine the individual item prices in 129 strata (about 60 percent of the strata in the CPI). Under some rather specific assumptions about the degree of substitution among goods and other matters, the geomeans approach will give the right answer from a cost-of-living standpoint. However, the assumptions about the extent of substitution are unlikely to hold precisely. Moreover, consumer responses to price differences may reflect something other than substitution behavior: for example, a consumer stocks up on particular items when sales occur but does not change the amount of those items purchased per month or per year. Nevertheless, most observers regard the adoption of geomeans as moving the CPI closer to a COLI.
The BLS has announced it will continue to use a Laspeyres approach—base period weights and arithmetic averaging—to combine the individual strata indexes into an overall CPI. In 2002 it will also publish an alternative index that uses a superlative index technique to combine the strata. However, a superlative index requires knowledge of consumer expenditure patterns in real time, and no country’s statistical system now produces such data. 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), making comparisons over the period of the mid-1980s to the mid-1990s, suggest that a superlative index would rise at about 0.15 percent a year less than the official CPI using fixed weights at the upper level. Of course, future patterns of inflation may differ, possibly producing a different comparison.
Substantial changes in consumer tastes pose problems for the use and interpretation of either a COGI or a COLI. The weights in a COGI have relevance because the index aims to measure the average price change for the things that people buy. If the pattern of purchases changes substantially, either because of substitution behavior or because tastes have changed, the relevance of a COGI diminishes. Since the composition of people’s spending is related to their income, age, and possibly other characteristics, changes in income distribution or demo-