Alternative CPI Aggregations: Two Approaches

Abstract

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. Other types of aggregation, such as the democratic index, 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 marAlternative CPI aggregations: two approaches

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