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How To Measure Living Standards And Productivity

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  • NICHOLAS OULTON

Abstract

This paper sets out a general algorithm for calculating true cost-of-living indices or true producer price indices when demand is not homothetic, i.e. when not all expenditure elasticities are equal to one. In principle, economic theory tells us how we should calculate a true cost-of-living index or Konüs price index: first estimate the consumer's expenditure function (cost function) econometrically and then calculate the Konüs price index directly from that. Unfortunately this is impossible in practice since real life consumer (producer) price indices contain hundreds of components, which means that there are many more parameters than observations. Index number theory has solved this problem, at least when demand is homothetic (all income elasticities equal to one). Superlative index numbers are second order approximations to any acceptable expenditure (cost) function. These index numbers require data only on prices and quantities over the time period or cross section under study. Unfortunately, there is overwhelming evidence that consumer demand is not homothetic (Engel's Law). The purpose of the present paper is to set out a general algorithm for the nonhomothetic case. The solution is to construct a chain index number using compensated, not actual, expenditure shares as weights. The compensated shares are the actual shares, adjusted for changes in real income. These adjustments are made via an econometric model, where only the responses of demand to income changes need to be estimated, not the responses to price changes. This makes the algorithm perfectly feasible in practice. The new algorithm can be applied (a) in time series, e.g. measuring changes over time in the cost of living; (b) in cross section, e.g. measuring differences in the cost of living and hence the standard of living across countries; and (c) to cost functions, which enables better measures of technical progress to be developed.
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Suggested Citation

  • Nicholas Oulton, 2012. "How To Measure Living Standards And Productivity," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 58(3), pages 424-456, September.
    • Handle: RePEc:bla:revinw:v:58:y:2012:i:3:p:424-456
    DOI: j.1475-4991.2012.00498.x
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    Cited by:

    1. Cooper, Russel J. & McLaren, Keith R. & Rehman, Fahd & Szewczyk, Wojciech A., 2015. "Economic welfare evaluation in an era of rapid technological change," Economics Letters, Elsevier, vol. 131(C), pages 38-40.
    2. Lejla TERZIĆ, 2020. "Is there a relationship between economic welfare and innovation performance? Evidence from selected European countries," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 0(4(625), W), pages 159-168, Winter.
    3. Dibyendu Maiti & Akshara Awasthi, 2020. "ICT Exposure and the Level of Wellbeing and Progress: A Cross Country Analysis," Social Indicators Research: An International and Interdisciplinary Journal for Quality-of-Life Measurement, Springer, vol. 147(1), pages 311-343, January.
    4. Sila, Urban, 2009. "Can family-support policies help explain differences in working hours across countries?," LSE Research Online Documents on Economics 28684, London School of Economics and Political Science, LSE Library.
    5. Ranjan Ray, 2017. "The Role of Prices in Welfare Comparisons: Methodological Developments and a Selective Survey of the Empirical Literature," The Economic Record, The Economic Society of Australia, vol. 93(301), pages 314-332, June.
    6. Oulton, Nicholas, 2015. "Understanding the space–time (in)consistency of the national accounts," Economics Letters, Elsevier, vol. 132(C), pages 21-23.
    7. Amita Majumder & Ranjan Ray & Kompal Sinha, 2014. "A Unified Framework for the Estimation of Intra and Inter Country Food Purchasing Power Parities with Application to Cross Country Comparisons of Food Expenditure: India, Indonesia and Vietnam," Monash Economics Working Papers 31-14, Monash University, Department of Economics.
    8. Amita Majumder & Ranjan Ray, 2020. "National and subnational purchasing power parity: a review," DECISION: Official Journal of the Indian Institute of Management Calcutta, Springer;Indian Institute of Management Calcutta, vol. 47(2), pages 103-124, June.
    9. Ana Rincon-Aznar, 2009. "Rates of return and alternative measures of capital input: 14 countries and 10 branches, 1971-2005," National Institute of Economic and Social Research (NIESR) Discussion Papers 347, National Institute of Economic and Social Research.
    10. Ngounou, Borice Augustin & Djiogag, Constant Fouopi & Domguia, Edmond Noubissi & Zanfack, Linda Tiague & Pondie, Thierry Messie, 2025. "Does fiscal decentralisation hamper happiness? Evidence from African countries," World Development Perspectives, Elsevier, vol. 37(C).
    11. Carol Corrado & Jonathan Haskel & Massimiliano Iommi & Cecilia Jona-Lasinio & Filippo Bontadini, 2024. "Data, Intangible Capital, and Productivity," NBER Chapters, in: Technology, Productivity, and Economic Growth, pages 193-243, National Bureau of Economic Research, Inc.
    12. Christian-Lambert Nguena & Honoré Tekam & Borice Augustin Ngounou & Sostella Arida TchoualaFeutsa, 2024. "Building Joyful cities: is urbanization always pave a path to happiness in Africa?," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 71(4), pages 847-874, December.
    13. Nicholas Oulton, 2023. "The effect of changes in the terms of trade on GDP and welfare: A Divisia approach to the System of National Accounts," Manchester School, University of Manchester, vol. 91(4), pages 261-282, July.
    14. Kim, H．Youn & Wong, K．K．Gary, 2025. "Food demand and intertemporal allocation of food expenditure," Economic Analysis and Policy, Elsevier, vol. 85(C), pages 656-674.
    15. Nicholas Oulton, 2022. "The Divisia approach to measuring output and productivity: with an application to the BEA-BLS integrated industry-level production account, 1987-2020," Discussion Papers 2217, Centre for Macroeconomics (CFM).

    More about this item

    JEL classification:

    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being
    • O47 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence

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