Individual and Social Cost-of-Living Indexes

Abstract

Summary The purpose of this paper is to present an econometric approach to cost-of-living measurement. This approach implements the economic theory of individual cost-of-living measurement pioneered by Konus [1939] almost six decades ago. In this paper we develop and implement a completely parallel theory of social cost-of-living measurement. Our approach to cost-of-living measurement is based on an econometric model of aggregate consumer behavior. The novel feature of this model is that systems of individual demand functions can be recovered uniquely from the system of aggregate demand functions. We derive cost-of-living indexes for individual households from systems of individual demand functions. Our key innovation in the economic theory of cost-of-living measurement is the introduction of an explicit social welfare function. Our social welfare function incorporates measures of individual welfare from our econometric model. In addition, this social welfare function employs normative criteria for evaluating transfers among individuals. Given measures of individual welfare from our econometric model, we can express the level of social welfare as a function of prices and of total expenditures of all consuming units. We present methods for translating changes in prices into measures of change in the social cost-of-living. Our definitions of social and individual cost-of-living indexes are perfectly analogous. Finally, we extend the concept of a social cost-of-living index to groups of consuming units with common demographic characteristics. Our definition of the group cost-of-living index is analogous to the definition of a social cost-of-living index. To implement a group cost-of-living index we require a group welfare function that is analogous to a social welfare function.