The Unspoken of Inflation
Cost of Good Index (COGI) vs Cost of Living Index (COLI)
Inflation is inevitable like Thanos in our economy and always brings attention that everyone couldn’t resist to talk. In the wake of long sleeping pandemic, demand for goods and services has been soared while supply unable to catch which led to high inflation. Inflation is necessary at certain level yet high inflation is undesirable. Recently, inflation reported at 9.1% in June 2022 measured by CPI (consumer price index) and higher from May 2022 at 8.6%.
Consumer price index (CPI) is a tool to measure inflation by calculating change in prices paid by customers at given time for goods and services however, CPI is debatable for being a good metric to measure inflation. CPI used to calculate cost of fixed goods and services for two given times known as cost of goods index (COGI) however, government has been revised the methodology into view cost of standard living known as cost of living index(COLI).
Let me explain in simple table.
Imagine basket of fixed goods and services consist of fruit and dairy, given items are banana and milk. In the past, you can have a hand of banana and a bottle milk for $ 22 but now it’s $25.20 then 2% inflation for fruit and 25% inflation for dairy. Since items are fixed at any given time, we will be looking the same items on basket for next year in constant calculation.
Now at basket you are given substitute for each group of goods. You can still able to get fruit and dairy even items are different given orange and soya milk. In the past, you can have a bag of oranges and a bottle of soya milk for $15 but now it’s $16 then 0% inflation for fruit and 10% for dairy even though milk surged 25% at the same time. Since items can be substituted for each given group of goods, we may have different items on basket for next year in different calculation.
Changes in methodology from cost of good index (COGI) to cost of living index (COLI) are hard to catch with naked eyes. Inflation seems lower by cost of living index (COLI) can create silently domino effect such as lower rate for minimum salary and higher estimation for real GDP than it really is.
Key Takeaways
- CPI methodology has been revised from cost of good index (COGI) to cost of living index (COLI)
- Poor and rich customers have different ‘standard of living’ let alone consumer behaviour
- Cost of living index (COLI) works if preferences are homotethic or similar
References
- U.S. Government Accountability Office. “Consumer Price Index: Update of Boskin Commission’s Estimate of Bias
- U.S. Bureau of Labor Statistics. “BLS Handbook of Methods: Chapter 17: Consumer Price Index
- Hill, R. J. (2004). Inflation measurement for central bankers. The future of inflation targeting, 140–60.
