The inadequacy of cost of living indices based on subjective preferences: an ethical and methodological critique

Abstract

In this paper we argue that there is scant justification for replacing the traditional fixed‐basket Laspeyres price index with so called ‘true cost of living indices’. We begin with a discussion of the possible explanations for some empirical results for inflation found for different social groups in Ireland in the late 1990s. Our arguments concerning appropriate inflation indices are primarily ethical and are not dependent on these results being interpreted in a non‐neoclassical vein. They do however gain extra force if one accepts non‐neoclassical explanations for the empirical results. We go on to draw conclusions as to how best to measure the welfare effects of changes in the price of goods. This links in to the broader debate regarding objective versus subjective measures of welfare.

Keywords:

• cost of living indices
• welfare

JEL classifications:

• E31
• P46

Acknowledgement

The authors would like to thank the Combat Poverty Agency of Ireland who funded the empirical research that formed the inspiration for this paper. They would also like to thank the referee for constructive comments on earlier drafts.

Notes

1. This would also be true for any kinds of preferences where the indifference map of a consumer changes as his income changes, for example, by exhibiting more or less substitutability in preferences.

2. A logical conclusion of the new welfare economics is the impossibility of policies designed to help the worse off because the policy maker has no basis for knowing who is worse off and who is better off.