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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
living are different things in practice, not just in theory. And, indeed, many of those who argue for the adoption of a comprehensive COLI approach see its treatment of such cases, not how it handles substitution, as the main advantage of COLI over COGI approaches.
One can, however, make the COLI give the same answer as the COGI by constructing a “conditional” cost-of-living measure, defined as the minimum expenditure on market goods needed to attain a given standard of living when the provision of nonmarket goods is at some specified level. In this way, the conditional COLI changes only when prices change. Without changes in prices, the conditional COLI is constant: it cannot be altered by changes in nonmarket goods or changes in the environment (such as the provision of the bridge) or by an increase in life expectancy.
The conditional COLI can be used to hold constant not just the provision of public goods but anything that one does not want to affect the price index. A good example is temperature: in unusually cold winters or hot summers, families have to spend more money to attain the same level of comfort (the same temperature in their homes). Should the CPI rise because the winter is unusually cold, even if the price of heating fuels remain constant? For the panel, the answer is no. The cost of living has gone up, but prices have not. We prefer a price index that does not change in response to temperature changes alone. For this reason, the preferred choice for a cost-of-living index is not the comprehensive or unconditional cost-of-living index but a conditional cost-of-living index that holds constant all environmental nonprice factors that affect people’s well-being.
The conditional cost-of-living index can exclude those things that people believe should be excluded—such as fluctuations in winter temperature—leaving it somewhat more like a price index and somewhat less like a cost-of-living index. For most purposes, a conditional COLI is arguably the right concept. It responds to price changes as a price index should, and it takes into account consumer substitution. Nevertheless, a conditional COLI has problems in dealing with some issues and arguably gives the wrong answer in some of them. Some economists object to almost any exclusions. For them a conditional cost-of-living index is no longer a cost-of-living index. Thus, in the case of a sales tax for a bridge, they think the value of the bridge should be taken into account or, if that is impractical, the increase in sales tax should be excluded from the price index. Similarly, the price index should be decreased for an increase in health status or a reduction in the crime rate because both reduce the amount of money required to reach a given standard of living. Although the Boskin report does not formally recommend such a position, it contains a number of statements that are sympathetic to such a treatment.
Even if such arguments are not rejected in principle, there are practical examples for which the case for a conditional COLI is unpersuasive. One example is the construction of regional or city price indexes. Nothing in cost-of-living theory says the base and comparison situations cannot be different places, rather than different times, and there are many situations in which such cross-