Cost Of Living Index 615v1d

What methods of Index Number calculation is used to calculate Cost of Living Index (CLI) A cost-of-living index is an ideal price index that measures differences in the price of goods and services over a period of time or region and allows for substitution to other items as prices vary. In simple , exact cost-of-living index is the cost of achieving a certain standard of living in one year relative to the cost of achieving the same level next year. Since we cannot directly measure the standard of living, therefore true cost-of-living index is only a theoretical concept not a practical price index formula. The consumer price Index is most of the times called a cost-of-living index but it is different in many important ways from a complete cost-of- living measure. Both I and CLI would reflect changes in the price of goods and services that are directly purchased in the market place but a complete CLI would also take into changes in governmental and environmental factors that affect consumer’s well-being. Cost -of-living index number can be constructed by the following two (02) formulae: 1. Aggregate expenditure method or weighted aggregative method. 2. Family budget method or method of weighted relatives. Aggregate expenditure method or weighted aggregative method In this method, approximate cost-of-living index is given by the formula

∑p q ∑p q

1 0

×100

0 0

Here,

p1

q0 p0

Refers to the prices of commodities in the current year Refers to the quantities of the base year Refers to the prices of the commodities in the base year

The prices of commodities for various groups for the current year are multiplied by the quantities of the base year and their aggregate expenditure of current year is obtained. Then the prices of commodities for base year are multiplied by the quantities of the base year and their aggregate expenditure of base year is obtained. Finally, the aggregate expenditure of the current year is divided by the aggregate expenditure of the base year and the quotient is multiplied by 100. Family budget method or method of weighted relatives In this method, the family budgets of a large number of people are collected and the aggregate expenditure of the average family on different items is used as weights. Then current year’s price are converted into price relatives on the basis of base year’s prices and these prices relatives are multiplied by the respective values of the commodities, in the base year. The summation of these products is divided by the sum of the weights and the resulting figure is the required index numbers.

In this method, approximate cost-of-living index is given by the formula

 pv v

Here,

v  p0 q0

, values for the base year

p p = 1 ×100 po

, for each item Let us consider an example shown in the table below (Values indicated are not actual). Commodi Quantit Prices ties y 200 201 consu 0 3 med in p1 p0 Kg in ( ) ( ) 2000(

q0

A B C

∑

p1q0 p0q0

6 5 4

) 100 200 50

200 300 100

= (1200+1500+400) = 3100

∑ = (600+1000+200)=1800 So, I = 172.22 Consumer Price Indexes or cost-of-living indexes are used in compensating the employees in form of increasing the allowances. While the Economist Intelligence Unit believes that the weighting pattern mentioned in this report fits the requirement, it is clear that special circumstances may arise whereby a company would feel that a modification in the weights might be needed. In such cases, the EIU has the authority to offer companies a "tailor-made" index based on any national or individual weighting pattern that may be necessary.