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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
Aggregation Across Consumers
A single price index must somehow represent the average experience of a very heterogeneous population, whose members buy different goods, of different qualities, at different prices, in different kinds of outlets and who exhibit different substitution behavior when relative prices change. If the differences were purely idiosyncratic, so that buying patterns, shopping behavior, and prices paid for the same good did not vary systematically according to whether people are rich or poor, old or young, or by other socioeconomic characteristics, alternative ways of aggregating individuals’ varied experiences into a single index would not, for most purposes, pose issues of any great significance. But buying patterns, shopping behavior, and prices paid do vary among different groups by income, age, and possibly other characteristics. And so, during any period in which the prices for the particular kinds and qualities of goods that are especially important to one group rise significantly faster or slower than average, the change in the CPI will under- or overstate the rise in the cost of living for that group.
This heterogeneity raises several issues in the construction of the CPI, which we discuss in Chapter 8. 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. To the extent that heterogeneity of substitution behavior is systematically related to income and demographic characteristics, the substitution effect incorporated in the overall index can vary with changes in income distribution and demographic balance. (In Chapter 2 we briefly consider the conceptual issues raised by this phenomenon, and in Chapter 8 we provide a fuller exposition.)
The second issue can be framed in the form of several questions: When is a single national index appropriate for the whole population, especially for such purposes as adjusting taxes and social security payments, and when are different indexes for different groups and geographic areas needed? If the latter, how does one collect the kind of data needed to produce subindexes that accurately reflect differences among population groups and locations?
Finally, even if it would be desirable to produce one or more subindexes, a single overall index would still be needed for many purposes—as a measure of national inflation, for example. For purposes of combining the prices of individual goods into the overall national CPI, weights are currently assigned to each good based on aggregate consumer expenditures for the item. Since the spending of a household is positively related to the level of its income, the consumption patterns and prices paid by the rich play a greater role in determining the rate of change in the overall CPI than do those of the poor. Because of their expenditure-based weights, the CPI and the corresponding indexes of virtually every country have been labeled plutocratic indexes. In an alternative democratic index, the