What Is the Cost of Living?

Cost of Living Index (CLI) The cost of living index refers to the ratio of the minimum expenditure required by a consumer to achieve a certain level of utility (or benefits, living standards) at different points in time, sometimes called constant Utility index (constant utility index), constant satisfaction index (constant satisfaction index), welfare index (welfare index), etc. The cost of living index is an index theory based on economics. The cost-of-living index theory believes that consumers' behaviors are rational. When prices change, consumers will adjust their consumption behaviors and consumption patterns to optimize consumption behaviors.

Cost of living index

The basic method of constructing the cost of living index is:

Cost of Living Index Benefits

First, the cost of living index is based on economic theory, and its analysis methods can be integrated into economics.

Second, the cost of living index can reflect consumers' alternative behavior, which is closer to economic reality.

Third, the cost of living index studies the effect of price changes on the cost of living and can be used for welfare analysis.

Fourth, the theoretical framework of the cost of living index can provide a good guide for the compilation of CPI, such as new product issues, determination of product prices, and selection of basic price index formulas.

Defective cost of living index

Although most economists support the cost of living index, criticism of the cost of living index has never stopped. In fact, economic theory itself has flaws, so some flaws are not only the flaws of the cost of living index, but also the flaws of economic theory itself.

Measure of Utility

The cost-of-living index considers consumers to be rational and to pursue maximum utility under certain constraints. But how is utility measured? In the history of economics, economists first used cardinal numbers to measure utility directly. This is the cardinal utility. At the end of the 19th century and the beginning of the 20th century, economists doubted the hypothesis that utility can be directly measured, and then proposed the concept of ordinal utility. But ordinal utility brings new difficulties to economics: if utility cannot be measured, how to explain that consumer choice is determined by preference or utility maximization? In order to solve the contradiction contained in "ordinal utility theory", Samuel In 1938, Elson proposed the Revealed Preference Theory: Although utility as a subjective mental state is not observed, consumer behavior can be observed. Consumers choose a certain product combination in the market. His "Preferences" are also "displayed" at the same time, without the need to quantify the utility. But the biggest flaw of the displayed preference theory is that it is a circular argument that cannot be refuted and falsified by experience, because it is impossible to prove that as long as consumers choose a certain product combination, the utility must be maximized. If utility is not measurable, economists cannot define the maximization of utility from an empirical perspective. This will shake the foundation of the economic mansion, and people will inevitably have doubts about the cost of living index theory.

Behavioral economics

Challenges to Consumers' Rational Choice Behavior Economic theory holds that humans are rational, but due to the uncertainty and complexity of the environment, incomplete information, and the limited ability of human cognition, people's rational cognition will be psychologically affected. And the objective limitation of the physical thinking ability, therefore, human reason should be the limited reason that Herbert Simon said. Whether it is complete rationality or limited rationality, traditional economic theory believes that human behavior is rational after all.

But the development of psychology and behavioral economics has challenged consumers' rational choice behavior. Human behavior has its rational side as well as its irrational side. Rational behavior is not the only mode of behavior. Unconsciousness and irrationality are a phenomenon fully proven by modern psychologists and behavior scholars, such as emotional behavior, impulsive behavior. , Herd behavior, etc. In economic practice, people often know what the optimal solution is, but they cannot make the optimal choice because of self-control and willpower.

The 2002 Nobel Laureate in Economics, Daniel Kahneman, found that there is uncertainty in human judgments and decisions, that is, human judgments and decisions are often very different from predictions based on standard economic theory. Kahneman also distinguished the current utilitarian (moment-utility) and _remembered utility (remembered utility), thinking that human behavior depends on the recollection of the results of past behavior, and human behavior is "utilitarian in memory" Made after an assessment, which may lead to availability biases.

Change of preference

The consumer behavior theory of modern microeconomics describes consumer preferences as the order relationship in the space of consumer goods. The cost of living index does not compare product baskets on different indifference curves, but uses the same indifference curve to compare two periods. The cost-of-living index does not study how people's preferences are formed and the relationship between various preferences. This belongs to the research object of psychology and social psychology. The cost-of-living index assumes that the preferences of consumers remain unchanged, so it is a comparison. Static analysis.

Pseudo-preference problem

Although the cost-of-living index itself does not require hypothetical preferences, the hypothetical preferences can greatly simplify the cost-of-living theory. For example, the cost-of-living index and utility level are irrelevant only under the condition of preference. The cost-of-living index is between the Pap price index and the Laplace price index. The best price index is the second order of the cost-of-living index approximate.

Representative consumer issues

Many literatures discussing the cost-of-living index implicitly assume that there are representative consumers, that is, the cost-of-living index of a representative consumer represents the cost-of-living index of the entire society, which is in line with the relevant assumptions in economics. .

Changes in consumer composition

When summing up the cost-of-living index of individual consumers, it is always assumed that the composition of consumers in the base period and the reporting period remains the same. In real life, there are many factors that affect the composition of consumers, such as the birth of a child, the child becoming an adult, the middle-aged person becoming an elderly person, the death of a population, and migration. In the case of relatively small changes in the composition of consumers, this problem can be ignored, but if the composition of consumers changes greatly, this issue must be considered when adding up. A feasible method is to eliminate part of the traffic changes made up by consumers and only keep the consumers who have not changed.