In contrast to a COGI, a COLI framework builds on the economic theory of consumer behavior. Many would argue that this theory is so simple and obvious that there is little reason not to adopt it, but as we have shown in the previous section, this is not clear to everyone. Still, there are great benefits from using the theory. The idea that, as prices change, people substitute toward relatively cheaper goods strikes most people as reasonable, and the theory provides the apparatus to deal with this idea in a formal way. Given the idea, one has a good basis for the further idea that someone with enough money to buy the original bundle in the new situation is at least as well off as before and may be better off, which is the idea of substitution bias (though there is still the further step, that a measure of compensation is the same as a measure of the change in the price level; see below). Many (although not all) price statisticians around the world have at least muted their original suspicions of the COLI approach in the face of its usefulness for thinking about important practical issues, such as the problems with constructing lower-level price indexes. As Triplett (1999) argues, economists use the theory of consumer behavior for all sorts of purposes, and their very success as public policy practitioners attests to the usefulness of their approach, even if they do not believe its literal truth. However, skeptics might attribute the same success to economists’ willingness to rely on deductive reasoning even in the face of contrary evidence (such as that reviewed above).

Public Perception and Understanding

When it comes to public understanding, basket price indexes have an advantage over cost-of-living indexes: they are simple and can be explained in seconds to almost anyone. Against this must be noted that, in practice, the actual (modified) Laspeyres indexes used by the BLS are quite complex, so that much of the clarity is lost in day-to-day practice. However, this is true of almost any complex measure or, indeed, any complex object. One might understand very well in a general way why an airplane flies, and the knowledge probably makes people feel better when flying. But the detailed construction of a modern airliner is certainly unknown to almost everyone.

The cost-of-living index is a good deal harder to explain. The basic concept of comparing how much it costs to live at different prices is relatively straightforward, but making the concept practical or precise is quite difficult, sometimes even for those who support the concept. Part of the problem may be less a lack of understanding than a genuine intellectual resistance to the approach. For example, there is nothing incoherent in a position that accepts the argument about substitution bias and accepts that fixed-bundle compensation is overcompensation, but does not accept that the price level and the level of compensation are the same thing, or that the cost of things is the same as the cost of living. According to this view, the COLI is the right framework for calculating compensation, but not necessarily for calculating the price index.

The National Academies | 500 Fifth St. N.W. | Washington, D.C. 20001
Copyright © National Academy of Sciences. All rights reserved.
Terms of Use and Privacy Statement