Even so, it is important not to expect too much of any conceptual framework. In the words of Commissioner Abraham (Bureau of Labor Statistics, 1997c), “the cost-of-living index is a theoretical construct, however, not a single or straightforward index formula readily amenable to practical use.” The consumer price index means different things to different people, and it is used in many, possibly contradictory, ways. An index that is good for one purpose will not always be good for another. It is a lot to ask of any one measure that it provide a general indicator of the level of prices in the country as a whole, that it yield an accurate measure of how much Congress intended social security recipients to be compensated for price changes, that it should hold constant the “real” rate of income taxation, that it should be an appropriate escalator for the poverty line as well as for a host of government, business, and private contracts involving a wide range of people, and that it should be useful to the Federal Reserve Board for setting monetary policy. Each purpose leads to a somewhat different conceptual framework. And as the panel’s own discussions have made clear, some of the most difficult issues, such as what to do about quality change, particularly but not exclusively in the provision of medical care, do not seem to be adequately handled by any of the conceptual frameworks currently available, or at least not in a way that commands widespread assent.
The remainder of the chapter has four major sections and a technical note. The first section provides some preliminary definitions of what is meant by a cost-of-living index and by a basket price index. It also lays out some practical considerations that limit the usefulness of at least some of the concepts that might be attractive in theory. The second major section presents the theory of the cost-of-living index. The COLI is rooted in a simple economic theory of consumer behavior that is the workhorse for much practical economic discussion and policy making. For economists, the discussion in the first part of this section will be familiar, although as became apparent in the public discussions on the CPI, this theory is often only vaguely understood. It is often criticized for defects or praised for charms which it may or may not possess. But even when fully understood, the theory is not immune to criticism of its behavioral assumptions, its empirical predictions, nor its approach to well-being. These criticisms, many of which derive from the literature in psychology, are also reviewed in this section.
The next section presents a discussion of specific topics, such as how to relate price indexes for individuals or groups of people to indexes for the nation, how to choose the prices that are appropriately included in a consumer price index, how to use price indexes to compensate people or groups of people for price change, and how to adjust price indexes for changes in the quality of goods. For each topic, we show how the different conceptual approaches are relevant, and how concrete application leads to sharpening and redefinition of the concepts. Although almost all of the topics are dealt with again in subsequent chapters, they need to be covered here in order to develop the conceptual apparatus that will later be used. We present conclusions in the third major section.