The true cost-of-living index with changing preferences

This article investigates the theoretical and empirical properties of a true cost-of-living index under conditions of changing preferences. A family of true indexes is defined based on the notion of the current utility function. A particular index, based on the previous period’s utility level, is then defined. Given this definition, a true cost-of-living index is computed based on a quadratic expenditure system estimated with quarterly data from 1960-1981. For empirical purposes, changes in preferences are represented by the linear habit formation hypothesis. This index is then compared with Paasche and Laspeyres indexes. The true cost-of-living index grows somewhat faster than either the Paasche or Laspeyres index. It also displays considerably more variability.