The measurement of inflation and changes in the cost of living

Abstract

The paper first examines the differences between price indexes with fixed quantity weights designed to measure consumer inflation and cost of living (CoL) indexes which compare the costs of two baskets of goods and services which are not quite the same but yield equal utility. For any specified CoL index, it is always possible to find a fixed weight price index of equal value and it is shown that the requisite quantity weights can be obtained as a linear combination of the actual quantities in both the periods being compared and are therefore more representative of the quantities purchased over the entire length of time spanned by the index. Thus, the fixed weight price index which equals the CoL index is typically a better measure of inflation than a conventional Laspeyres or Paasche index. There is no conflict between measuring inflation and measuring changes in the CoL. The reason why many actual fixed weight consumer prices indexes provide biassed estimates of changes in the CoL is that they are also poor measures of inflation.