Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/71540
Authors: 
Crossley, Thomas F.
Pendakur, Krishna
Year of Publication: 
2006
Series/Report no.: 
IFS Working Papers, Institute for Fiscal Studies (IFS) 06/10
Abstract: 
We present a new class of social cost-of-living indices and a nonparametric framework for estimating these and other social cost-of-living indices. Common social cost-of-living indices can be understood as aggregator functions of approximations of individual cost-of-living indices. The Consumer Price Index (CPI) is the expenditure-weighted average of first-order approximations of each individual’s cost-of-living index. This is troubling for three reasons. First, it has not been shown to have a welfare economic foundation for the case where agents are heterogeneous (as they clearly are.) Second, it uses an expenditure-weighted average which downweights the experience of poor households relative to rich households. Finally, it uses only first-order approximations of each individual’s cost-of-living index, and thus ignores substitution effects. We propose a “common-scaling” social cost-of-living index, which is defined as the single scaling to everyone’s expenditure which holds social welfare constant across a price change. Our approach has an explicit social welfare foundation and allows us to choose the weights on the costs of rich and poor households. We also give a unique solution for the welfare function for the case where the weights are independent of household expenditure. A first order approximation of our social cost-of-living index nests as special cases commonly used indices such as the CPI.We also provide a nonparametric method for estimating second-order approximations (which account for substitution effects). – Inflation ; Social cost-of-living ; Demand ; Average Derivatives
JEL: 
D11
D12
D63
E31
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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