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The substitution bias of the consumer price index

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Abstract

The paper uses elementary consumer theory to propose an inflation independent ratio definition of the substitution bias of the Laspeyres consumer price index, and derives an approximate substitution bias which depends on the size of the price change as measured by a norm in the Laspeyres plane and on the elasticity of substitution in the direction of the price change. This norm or distance measure can be interpreted as a price substitution index which yields useful information about the movements of relative prices. Norwegian CPI data are used to quantify these relationships.

Suggested Citation

  • Petter Frenger, 2006. "The substitution bias of the consumer price index," Discussion Papers 451, Statistics Norway, Research Department.
  • Handle: RePEc:ssb:dispap:451
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    File URL: http://www.ssb.no/a/publikasjoner/pdf/DP/dp451.pdf
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    1. Tran, Van Hoa, 1969. "Additive Preferences and Cost of Living Indexes: An Empirical Study of the Australian Consumer's Welfare," The Economic Record, The Economic Society of Australia, vol. 45(111), pages 432-440, September.
    2. Matthew D. Shapiro & David W. Wilcox, 1997. "Alternative strategies for aggregating prices in the CPI," Review, Federal Reserve Bank of St. Louis, issue May, pages 113-125.
    3. Diewert, W. E., 1976. "Exact and superlative index numbers," Journal of Econometrics, Elsevier, vol. 4(2), pages 115-145, May.
    4. Lloyd, P J, 1975. "Substitution Effects and Biases in Nontrue Price Indices," American Economic Review, American Economic Association, vol. 65(3), pages 301-313, June.
    5. E. T. McPHEE., 1928. "Notes," The Economic Record, The Economic Society of Australia, vol. 4(1), pages 92-95, May.
    6. W. Erwin Diewert, 1998. "Index Number Issues in the Consumer Price Index," Journal of Economic Perspectives, American Economic Association, vol. 12(1), pages 47-58, Winter.
    7. Goldberger, Arthur S. & Gamaletsos, Theodore, 1970. "A cross-country comparison of consumer expenditure patterns," European Economic Review, Elsevier, vol. 1(3), pages 357-400.
    8. Deaton,Angus & Muellbauer,John, 1980. "Economics and Consumer Behavior," Cambridge Books, Cambridge University Press, number 9780521296762, May.
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    More about this item

    Keywords

    consumer price index (CPI); substitution bias; elasticity of substitution.;

    JEL classification:

    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis

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