INFO 4470/ILRLE 4470 Price Indices: Theory and

Applications

John M. Abowd and Lars VilhuberFebruary 28, 2011

2

Outline

• The basic problem• Consumer theory and cost-of-living indices• Introduction to the Consumer Price Index (CPI-U

and CPI-W)• Index number formulae• Estimation of the quantity weights• Estimation of the prices• Building the index• The chained alternative (C-CPI-U)

3

The Basic Problem

• When prices and quantities both change, provide a measure of the change in the cost of living

• Decompose this measure into a price index that captures the overall change in prices and a quantity index that captures the overall change in quantities

4

The Cost of Living Index

• The cost of living index is defined as the minimum expenditure necessary to achieve a given utility level

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Introduction to the Consumer Price Index (CPI-U and CPI-W)

• The Consumer Price Index for all urban areas (CPI-U) is the basic national index

• BLS CPI Home Page• The Consumer Price Index for urban wage and

salary workers (CPI-W) is customized for households where the head is a wage and salary worker

8

CPI Basic Formulae• The lower-level components

of the CPI-U are estimated using the geometric formula

• The aggregate CPI-U is estimated using the Laspeyres formula

• The chained C-CPI-U is estimated using same lower-level components but with the Tornquist formula applied to the components

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Estimation of the Quantity Weights

• Consumer Expenditure Survey• Diary Survey (small frequent purchases)• Interview Survey (purchases with 3 month or

longer recall, major purchases)

Estimation of the Prices

• Census Bureau Telephone Point-of-purchase Survey Identifies Retail Outlets

• Item prices are surveyed by BLS on schedules varying from monthly to annual

• Quality adjustments use hedonic pricing methods

Building the Index

• Areas-items determine 8,018 combinations• See formulae in Handbook, Chapter 17, pages

35-40

Chained Alternative

• See Chained Alternatives (C-CPI-U) • For the NIPA the chained-dollar indices use

the Fisher formula. See Chained-Dollar Indexes.