Cost of Living Indices and Flexible Consumption Behaviour: A partial critique

This paper questions the alleged superiority of superlative prices indices (like the Fisher index) over more standard base year indices (like the Laspeyre index) as measures of changes in the “cost of living” (COL). The primary basis of our challenge is the “subjective” concept of welfare favoured by neo-classical economists. As shown by our results, a subjective welfare approach is relatively disadvantageous to those exhibiting more flexible preferences. Given that flexible behaviour could be a characteristic of the more income constrained and the not unreasonable possibility that preferences are income determined, the neo-classical COL approach is problematic in its axiomatic foundations, in its informational requirements and from an equity perspective. By contrast, with base year indices we objectively know what it is we are measuring. This is consistent with the defence by Sen (1985) and others of objective measures of welfare, which are also more conducive to progressive social policy than are subjective utility measures.