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November, 2000, Vol. 123, No. 11
Alternative CPI aggregations: two approaches
The theory of the cost-of-living index, which underlies the Consumer Price Index (CPI), is formulated within the context of the preferences and welfare of the individual. To construct an aggregate price index for a population requires that some method of aggregation be used to "average" the effects of price changes on all households in the population. It is intended that this aggregate index represent the "average" or "representative" household.
In most cases (including the CPI), the aggregation method used corresponds to a plutocratic index.1 Other types of aggregation, such as the democratic index,2 are also possible, and, in terms of economic theory, equally valid. However, as this article explains in a later section, the plutocratic approach is much more practicable, and it may provide a different measure of price change than the democratic index.
This article provides an empirical analysis of the differences between the plutocratic and democratic price indices, using data from the Consumer Expenditure Survey and the CPI for the 1987–97 period. The analysis constructs household-specific price indices from the Consumer Expenditure Interview sample, using the U.S. national average CPI series for all these households at the most detailed level of commodity disaggregation possible. Because the U.S. economy experienced low inflation during the 1987–97 period, this analysis also includes some hypothetical scenarios of price change. While it is impossible to predict what prices will do in future markets, these scenarios provide some information on the sensitivity of the differences between the plutocratic and democratic indices.
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ACKNOWLEDGMENT: The author would like to thank Rob Cage for supplying data and Mathew Taylor for assisting in the research.
1 The plutocratic index is an aggregate price index in which the relative level of total expenditures of each household provides the weights. For more information, see W. E. Diewert, "The Theory of the Cost-of-Living Index and the Measurement of Welfare Change," in W. E. Diewert and C. Montmarquette, eds., Price Level Measurement (Statistics Canada, 1983), pp. 163–233.
2 The democratic index is an aggregate price index in which each household’s expenditure patterns are equally weighted. For more information, see W. E. Diewert, "The Theory of the Cost-of-Living Index," pp. 163–233.
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