The Consumer Price Index and index number purpose1

The paper considers the use of a Consumer Price Index (CPI) for three possible purposes: (1) as a Cost of Living Index (COLI); i.e., as a measure of the relative cost of achieving the standard of living when facing two different sets of prices for the same group of commodities; (2) as a consumption deflator; i.e., the price change component for a decomposition of a value ratio into price and quantity components and (3) as a measure of general inflation. The theoretical concepts suitable for the first two purposes are laid out and the problems involved in finding practical approximations to the unobservable theoretical constructs are discussed. The concept of a conditional cost of living index is also discussed; this type of index holds constant various environmental factors. The problems involved in aggregating over groups of consumers are also discussed. Finally, the differences between the harmonized index of consumer prices used in the European Union to measure general inflation and a COLI are discussed.