Problems of operationalizing the concept of a cost-of-living index

Abstract

The aim of our paper is to discuss the problems of operationalizing the concept of a .cost-of-living-index. (COLI). For this purpose we are first undertaking a theoretical analysis of Diewert’s theory of superlative index numbers as one possible approach to approximate a COLI. We show that Diewert.s superlative index approach is arguable in many points and that the approach requires restrictive assumptions which are not likely to be met in observed households behaviour. To get a better idea about the deviation of observed households behaviour from the neoclassical assumptions about utility maximizing behaviour, we are estimating an Almost Ideal Demand System and a Quadratic Almost Ideal Demand System with cross section micro data from the German income and expenditure survey. Using the results of the demand system estimations we calculate COLIs and compare them with superlative index numbers and the Laspeyres price index.cost-of-living index; superlative index numbers; Diewert; demand systems