Index-number tests and the common-scaling social cost-of-living index

For a change in prices, the common-scaling social cost-of-living index is the equal scaling of each individual’s expenditure level needed to restore the level of social welfare to its prechange value. This index does not, in general, satisfy two standard index-number tests. The reversal test requires the index value for the reverse change to be the reciprocal of the original index. And the circular test requires the product of index values for successive price changes to be equal to the index value for the whole change. We show that both tests are satisfied if and only if the Bergson-Samuelson indirect social-welfare function is homothetic in prices, a condition which does not require individual preferences to be homothetic. If individual preferences are homothetic, however, stronger conditions on the Bergson-Samuelson indirect must be satisfied. Given these results, we ask whether the restrictions are empirically reasonable and find, in the case that individual preferences are n...

• Type: Journal
• Year: 2012
• Where: SCW
• Authors: David I. Donaldson, Krishna Pendakur
• Keywords: Applied Computing, Journal Of Economic Literature, Reversal Test, SCW 2012, Social Welfare Function