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Using a Constant Elasticity of Substitution Index to Estimate a Cost of Living Index: From Theory to Practice

Author

Listed:
  • Lorraine Ivancic

    (School of Economics, The University of New South Wales)

  • Erwin Diewert

    (Department of Economics, University of British Columbia)

  • Kevin J. Fox

    (School of Economics, The University of New South Wales)

Abstract

Indexes often incorporate various biases due to their methods of construction. The Constant Elasticity of Substitution (CES) index can potentially eliminate substitution bias without needing current period expenditure data. The CES index requires an elasticity parameter. We derive a system of equations from which this parameter is estimated. We find that consumers are highly responsive to price changes at the elementary aggregation level. The results support the use of a geometric rather than arithmetic mean index at the elementary aggregate level. However, we find that even the use of a geometric mean index at the elementary aggregate level may not sufficiently account for the observed level of consumer substitution.

Suggested Citation

  • Lorraine Ivancic & Erwin Diewert & Kevin J. Fox, 2010. "Using a Constant Elasticity of Substitution Index to Estimate a Cost of Living Index: From Theory to Practice," Discussion Papers 2010-15, School of Economics, The University of New South Wales.
    • Handle: RePEc:swe:wpaper:2010-15
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    File URL: http://research.economics.unsw.edu.au/RePEc/papers/2010-15.pdf
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    More about this item

    Keywords

    Price indexes; elasticity of substitution; scanner data;
    All these keywords.

    JEL classification:

    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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