Sources of Bias and Solutions to Bias in the Consumer Price Index

Abstract

Four sources of bias in the Consumer Prices Index (CPI) have been identified. The most discussed is substitution bias, which creates a second order bias in the CPI. Three other changes besides prices changes create first order effects on a correctly measured cost of living index (COLI). I explain in this paper that a “pure price” based approach of surveying prices to estimate a COLI cannot succeed in solving the 3 problems of first order bias. I discuss economic and econometric approaches to measuring the first order bias effects as well as the availability of scanner data that would permit implementation of the techniques.

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