This is a point that most economists outside of pen-l will not be
able to understand (and perhaps this is why Dave Richardson recommends that
those fighting the CPI revisions should focus on sources of downward bias),
but there is no legitimate, logically consistent reason for attempting to
measure substitution effects in the CPI. The CPI is a *price* index, not a
cost of living index. Conceptually, there is no difference between trying to
measure substitution effects, and trying to measure how every other economic
change that occurs with growth, relative price changes, changing consumption
patterns, changes in income distribution, etc. affects people's well-being.
In other words, once you get away from simply trying to measure how
the price of a fixed bundle of goods changes over time, and into estimating
the subjective "utility" derived by consumers as their consumption patterns
change in response to price changes, there is no logical or conceptual
reason to measure a substitution effect but not look at how all these other
changes affect the cost of living. I think Dave is saying the same thing
when he mentions the automobile and telephone as goods that have become
necessities for many people, when they were once luxuries. Neoclassical
microeconomics does not generally recognize that the "utility" derived from
an individual's consumption is dependent on other people's consumption
patterns, so the neoclassical economists will not consider the changes that
Dave suggests should be incorporated, in any attempt to make the CPI more of
a "true" cost of living index (which is the alleged intent of the proposed
changes).
There are a number of other logical and conceptual errors in these
efforts to "fix" the Consumer Price Index-- especially the Boskin
Commission's hack job; those who want more detail can see Dean Baker's
latest book on the subject. Now for the practical implications, the
reporting on the BLS geometric mean experimental index has been very
misleading, creating the impression that there is .25 percentage points just
out there that are ripe for the taking. This serves the interests of Clinton
and those in Congress who want to substitute a lower measure for the CPI.
Whereas the BLS will not find anything near that (Dave you can correct me if
I am wrong) if and when they do actually try incorporate these changes into
the CPI.
But I still think that, whatever the motivation of the BLS in trying
to measure the substitution effects-- and I haven't seen any evidence that
it is a result of political pressure-- the decision to do so is, in the
sense described above, political. That is, it is arbitrary from a
logical/conceptual point of view, and will result in a lower measured rate
of inflation-- which will reduce Federal benefits as well as future real
wage gains. Fortunately, it will probably end up being a pretty small cut,
if it's left to the BLS.
Cheers,
Mark
-------------------------------------
Name: Mark Weisbrot
E-mail: <[EMAIL PROTECTED]>
Preamble Center for Public Policy
1737 21st Street NW
Washington DC 20009
(202) 265-3263 (offc)
(202) 333-6141 (home)
fax: (202)265-3647
--- On Mon, 14 Apr 1997 10:37:47 -0700 (PDT) Richardson_D
<[EMAIL PROTECTED]> wrote:
> Jim Devine is concerned that the move to the geomean may be largely
> political (see below).
>
> The argument in favor of the geomean is based largely on the idea that
> in the Laspeyres framework we are implicitly assuming a Leontieff
> (rectangular) utility function and an elasticity of substitution (ES)
> of 0.0. This has the implication that commodities must be consumed in
> exact proportions regardless of relative prices.
>
> The geometric mean implicitly assumes a Cobb-Douglas utility function
> with ES=1.0. In this case the share of income devoted to each
> commodity is unchanged and the deleterious effect of a price increase
> can be mitigated by substituting items whose prices have not risen.
>
> The idea of substitution as a possibility seems plausible to most
> people. A more promising tack in this debate is to concentrate on
> possible sources of downward bias in the index. For example, as
> technology advances certain products may become necessities. The most
> common examples are the telephone and the automobile. As
> "technological progress" has the result of lower density development
> and declining public transportation, more or less up to date modes of
> transportation and communication tend to become necessities, thus
> increasing the cost of living. This effect may not be picked up in
> the CPI.
>
> Dave Richardson
>
> ----------
> Sent: Monday, April 14, 1997 11:58 AM
> Subject: [PEN-L:9478] geometric-mean CPI
>
> besides the obvious political advantages of using the geometric-mean
> CPI
> (lowering the budget deficit), is there any _theoretical_ reason why
> it is
> superior to the old arithmetic-mean CPI?
>
> I am not impressed by the substitution effect story. If higher prices
> of
> beef drive me to eat chicken instead, I'm suffering (even though I
> might
> live longer as a result, which is not something the CPI is supposed to
> be
> measuring).
>
>
> in pen-l solidarity,
>
> Jim Devine [EMAIL PROTECTED]
> [EMAIL PROTECTED]
> Econ. Dept., Loyola Marymount Univ.
> 7900 Loyola Blvd., Los Angeles, CA 90045-8410 USA
> 310/338-2948 (daytime, during workweek); FAX: 310/338-1950
> "It takes a busload of faith to get by." -- Lou Reed.
>
>
>
>
---------------End of Original Message-----------------
