Problems of operationalizing the concept of a cost-of-living index

Problems of operationalizing the concept of a
“cost-of-living-index”

Claus C. Breuer, Peter M. von der Lippe
University of Duisburg-Essen
[email protected], [email protected]

July 6, 2011

Abstract

The aim of our paper is to discuss the problems of operationaliz-
ing the concept of a “cost-of-living-index” (COLI). For this purpose
we are first undertaking a theoretical analysis of DiewerFs theory of
superlative index numbers as one possible approach to approximate a
COLI. We show that DiewerFs superlative index approach is arguable
in many points and that the approach requires restrictive assump-
tions which are not likely to be met in observed households’ behav-
iour. To get a better idea about the deviation of observed households’
behaviour from the neoclassical assumptions about utility maximizing
behaviour, we are estimating an Almost Ideal Demand System and a
Quadratic Almost Ideal Demand System with cross section micro data
from the German income and expenditure survey. Using the results
of the demand system estimations we calculate COLIs and compare
them with superlative index numbers and the Laspeyres price index.

1 Introduction

In some countries, especially the USA the prefered target of inflation mea-
surement is the so called “cost-of-living-index” (COLI, or index of Konhs
P^) as opposed to the traditional approach to define a consumer price index
(CPI) which is based on a constant “basket” of goods (also known as cost

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