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Substitution Bias and the Construction of a Spatial Cost of Living Index

  • Dusan Paredes


    (IDEAR - Department of Economics, Universidad Católica del Norte - Chile)

  • Víctor Iturra


    (IDEAR - Department of Economics, Universidad Católica del Norte - Chile)

We estimate the spatial substitution bias based on the difference between a price index and the true cost of living. We estimate the substitution bias for several different geographical scales, using different base baskets and across several spending quartiles. Our results show a significant substitution bias for small geographic units. The choice of the base basket is relevant for the estimation of the bias. Finally, the spatial substitution bias is higher for higher level quartiles due to the heterogeneity in the consumption basket. This exercise shows how the spatial dimension modifies the construction of a price index. Moreover, the approach of fixed baskets (the axiomatic approach) should be carefully considered in the estimation of spatial price differentials.

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Paper provided by Universidad Catolica del Norte, Chile, Department of Economics in its series Documentos de Trabajo en Economia y Ciencia Regional with number 13.

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Length: 18 pages
Date of creation: May 2011
Date of revision: May 2011
Handle: RePEc:cat:dtecon:dt201103
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  1. Koo, Jahyeong & Phillips, Keith R & Sigalla, Fiona D, 2000. "Measuring Regional Cost of Living," Journal of Business & Economic Statistics, American Statistical Association, vol. 18(1), pages 127-36, January.
  2. Dusan Paredes & Patricio Aroca, 2008. "Metodología para Estimar un Indice Regional de Costo de Vivienda en Chile," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 45(131), pages 129-143.
  3. Combes, Pierre-Philippe & Duranton, Gilles & Gobillon, Laurent, 2004. "Spatial Wage Disparities: Sorting Matters!," CEPR Discussion Papers 4240, C.E.P.R. Discussion Papers.
  4. Rosen, Sherwin, 1974. "Hedonic Prices and Implicit Markets: Product Differentiation in Pure Competition," Journal of Political Economy, University of Chicago Press, vol. 82(1), pages 34-55, Jan.-Feb..
  5. Braithwait, Steven D, 1980. "The Substitution Bias of the Laspeyres Price Index: An Analysis Using Estimated Cost-of-Living Indexes," American Economic Review, American Economic Association, vol. 70(1), pages 64-77, March.
  6. Michael J. Boskin, 1998. "Consumer Prices, the Consumer Price Index, and the Cost of Living," Journal of Economic Perspectives, American Economic Association, vol. 12(1), pages 3-26, Winter.
  7. Iturra, Victor & Paredes - Araya, Dusan, 2011. "Construction of a Spatial Housing Price Index by Estimating an Almost Ideal Demand System," MPRA Paper 30581, University Library of Munich, Germany.
  8. Pollak, Robert A., 1989. "The Theory of the Cost-of-Living Index," OUP Catalogue, Oxford University Press, number 9780195058703.
  9. Topel, Robert H & Rosen, Sherwin, 1988. "Housing Investment in the United States," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 718-40, August.
  10. Bowden, Roger J, 1992. "Competitive Selection and Market Data: The Mixed-Index Problem," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 625-33, July.
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