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

30 Pages Posted: 11 Nov 2010

See all articles by Lorraine Ivancic

Lorraine Ivancic

University of New South Wales (UNSW)

W. Erwin Diewert

University of British Columbia (UBC) - Department of Economics; National Bureau of Economic Research (NBER)

Kevin J. Fox

UNSW Australia Business School, School of Economics

Date Written: November 10, 2010

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.

Keywords: Price indexes, elasticity of substitution, scanner data

JEL Classification: C43, E31

Suggested Citation

Ivancic, Lorraine and Diewert, W. Erwin and Fox, Kevin J., Using a Constant Elasticity of Substitution Index to Estimate a Cost of Living Index: From Theory to Practice (November 10, 2010). UNSW Australian School of Business Research Paper No. 2010 ECON 15. Available at SSRN: https://ssrn.com/abstract=1706953

Lorraine Ivancic

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

W. Erwin Diewert

University of British Columbia (UBC) - Department of Economics ( email )

997-1873 East Mall
Vancouver, BC V6T 1Z1
Canada
604-822-2544 (Phone)
604-822-5915 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Kevin J. Fox (Contact Author)

UNSW Australia Business School, School of Economics ( email )

High Street
Sydney, NSW 2052
Australia
(02)9385-3320 (Phone)
(02)9313-6337 (Fax)

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