Criticisms of the CPI

We have pointed out that the Consumer Price Index is not really a "cost of living" index. According to the Boskin Commission, "The change in the cost of living between two periods, for example 1975 and 1995, tells us how much income people would have needed in 1975, given the prices of goods and services available in that year, to be at least as well off as they are in 1995 given their income and the prices of goods and services available then." That is, it is the cost of buying the same standard of living that the average person enjoyed in the base year. But "The CPI is not a cost of living index, but rather a fixed weight index, implemented by means of a modified Laspeyres formula," according to the Commission. The Consumer Price Index tells us the cost, in current prices, of the quantities of goods that people bought in a specific "base" year. As such, it is an approximation to the "cost of living." How good an approximation? This was assessed by the Boskin Commission in Toward A More Accurate Measure Of The Cost Of Living As reported to the Senate Finance Committee by the Advisory Commission To Study The Consumer Price Index. They found that the Consumer Price Index is a poor approximation to a Cost of Living Index, because of four kinds of bias in the Consumer Price Index. The four forms of bias were:

• substitution bias
• outlet substitution bias
• quality change bias
• new product bias

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