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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
of apples or different brands of VCRs. Common sense suggests that consumers are much more willing and able to substitute between two kinds of apples than between an apple and an orange or between two kinds of VCRs than between a VCR and a stereo system. Some lower-level categories like medical supplies or sporting equipment are clearly different: a left-leg prosthesis is not a very good substitute for a right-leg prosthesis, nor a golf club for a tennis racket! Conversely, some goods within an item category may be more substitutable for each other than is explicitly assumed by the BLS procedure for combining prices at the lower level.
At this disaggregated level, the COLI perspective has a distinct advantage because substitution is clearly important and because the COLI recognizes it. It is probably easy to explain to consumers that an increase in the price of a Gala apple is not so serious as (i.e., requires less compensation than) an increase in the price of all apples, even if they usually buy the Galas. And the COLI approach gets this right. In response to this sort of argument and after publication of the Boskin commission’s report, the BLS switched from its previous Laspeyres approach to a weighted geometric means procedure (though not for all categories, including artificial limbs). This geomean method will give the right answer under rather specific assumptions about the degree of substitution between goods. Although the specific assumptions are unlikely to be exactly true, most observers regard the change in procedure as an improvement. The change also marks the BLS’s own change of perspective from a COGI conceptual basis (informed by COLI considerations) to an explicit COLI basis. It is probably the BLS’s first attempt to build substitution effects into the CPI itself, rather than into an experimental index.
We also note that, even prior to the introduction of the geomean procedure, the BLS used a seriously modified Laspeyres index that incorporated a procedure called seasoning, by which the weights come from a different period than either the reference or the comparison periods. The seasoned Laspeyres (including other modifications) used by the BLS was a long way from the simple fixed-basket approach, so that much of the original simplicity of the concept had already been lost. Analysis of the effects of seasoning (for example, by Shapiro and Wilcox, 1996, following the analysis of Reinsdorf and Moulton, 1995) shows that a seasoned index has different biases than an “unseasoned” index, so that it is not clear that the geomean index will always be practically superior to the seasoned Laspeyres (see “Technical Note” for more discussion).
Quality adjustment is possibly the area in which the COLI has the greatest advantage over the COGI approach. For the COGI, there are both practical and conceptual difficulties in trying to work with a fixed basket of goods when the functions and even definitions of goods change. When qualities are changing