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INFO 4470/ILRLE 4470 Price Indices: Theory and Applications

INFO 4470/ILRLE 4470 Price Indices: Theory and Applications. John M. Abowd and Lars Vilhuber February 28, 2011. 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

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INFO 4470/ILRLE 4470 Price Indices: Theory and Applications

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  1. 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

  5. Basic Formulae

  6. u(t=0) u(t=1) X 2 A: original t=0 B: t=1 (Laspeyres) C: Theoretical D: t=0 (Paasche) D A B C X 1

  7. 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. 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 CPI Basic Formulae

  9. Estimation of the Quantity Weights • Consumer Expenditure Survey • Diary Survey (small frequent purchases) • Interview Survey (purchases with 3 month or longer recall, major purchases)

  10. 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

  11. Building the Index • Areas-items determine 8,018 combinations • See formulae in Handbook, Chapter 17, pages 35-40

  12. Chained Alternative • See Chained Alternatives (C-CPI-U) • For the NIPA the chained-dollar indices use the Fisher formula. See Chained-Dollar Indexes.

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