Past Events

Constructing a Better Price Index

May 11, 2017

What’s the best way to evaluate international differences in living standards? How can we compare the value of 100 dollars to an American with 100 taka to a Bangladeshi?

Sanjay ReddyIn the November 17, 2015, seminar hosted by SCEPA and The New School Economics Department, New School Economics Professor Sanjay Reddy presented his research on the most appropriate choice of price index. According to Reddy, the most commonly used price indices are deeply flawed. However, with careful reasoning, informative and honest indices are achievable.

Reddy is critical of the most widely used methods for constructing price indices. While cynics claim that a perfect index number doesn’t exist, so anything goes, Reddy argues that certain indices are most appropriate for certain circumstances. Just as we use scales to measure weights and rulers to record heights, we should use different indices for different purposes as long as they fit the task at hand and are used consistently. For example, you can’t answer the question “who’s taller?” by measuring one person’s height and another’s weight.

The most widely used approach to constructing price indices is a “representative agent” model, where researchers assume that individuals are rational utility-maximizers, and infer budget constraints and utility functions from observed consumption behavior. According to Reddy, this approach is unconvincing. It may not be an accurate description of how people make decisions, and it fails to satisfy the axioms of the consumer choice theory on which it relies.

Instead, Professor Reddy proposes a set of criteria from which a more reliable price index can be constructed. His own project, The Global Consumption Consumption and Income Project (GCIP), aims to provide a more comprehensive understanding of how a country’s well-being evolves over time and can be compared internationally.