Spatial Comparisons of Prices and Expenditure in a Heterogeneous Country: Methodology with Application to India

This study addresses two significant limitations in the literature on cross-country expenditure comparisons: (a) treatment of all countries, large and small, as single entities with no spatial differences inside the countries, and (b) use of Divisia price indices, rather than preference based “exact price” indices, in the expenditure comparisons. This paper proposes alternative preference consistent methods for estimating spatial price differences in a large heterogeneous country such as India. Unlike the conventional price indices, the use of demand systems based methods allows the incorporation of price induced substitution effects between items. The paper illustrates the usefulness of the methodology by using the “exact” spatial price indices, in conjunction with the inequality sensitive welfare measure due to Sen, to rank the Indian states and examine changes in ranking duirng one of the most significant periods in independent India. The results have methodological and empirical implications that extend much beyond India.