Academic journal article International Journal of Business

Study on Taiwan Consumers' Cost of Living: An Application of the Additive Törnqvist Price Index Formula

Academic journal article International Journal of Business

Study on Taiwan Consumers' Cost of Living: An Application of the Additive Törnqvist Price Index Formula

Article excerpt

ABSTRACT

According to the estimates from the additive Törnqvist price index formula, Taiwan consumers' true cost of living grew by 29.93% with an average yearly growth rate of 1.76% during the 1991-2006 period. Nearly 85% of the total growth of cost of living derived mainly from seven commodity groups. In particular, supplementary food had made the largest contribution to the growth of cost of living over the period was because its price had increased by as high as 53.42%, and Taiwan consumers had spent around one-tenth of their total income on it. Compared with the estimates from Törnqvist price index, the Laspeyres price index had overestimated the growth of Taiwan consumers' cost of living in yearly average by 0.1 percentage points (ppts) over the sample period; the resulting substitution bias was mainly due to six commodity groups that had significant price changes. Based on our study, we would like to suggest that the Price Statistics Department in Taiwan consider compiling and publishing an alternative consumer price index (CPI) using the Törnqvist price index in Taiwan.

JEL classification: D12

Keywords: Törnqvist price index; Konyus cost of living index; Substitution bias; Laspeyres price index

(ProQuest: ... denotes formulae omitted.)

I. INTRODUCTION

There are very few empirical studies on Taiwan consumers' cost of living; however, the issue is becoming increasingly important in Taiwan because many economic and social welfare policies already include escalator clauses related to cost of living in order to take the impact of inflation on consumers' real purchasing power into consideration.1 Normally, the escalator clauses only use the officially published Consumer Price Index (CPI) as the basis for adjustments due to changes in the cost of living in Taiwan. Since the CPI, which is computed with the Laspeyres index formula, uses consumers' base-period commodity expenditure shares as the aggregate weights and fails to consider consumer optimal choice behavior, it will over-estimate consumes' cost of living and produce a "substitution bias"2 into the measurement (Braithwait, 1980; Manser & McDonald, 1988).3 Hence, the current approach would not only distort the distribution of income but would consequently also aggravate economic inequality in Taiwan.

In this paper, we have utilized the Törnqvist price index, in particular, with an additively decomposed formula suggested by Reinsdorf et al. (2002) to measure the growth level of Taiwan consumers' cost of living over the period of 1991-2006. Using the Törnqvist price index to measure consumers' cost of living standards has many advantages. First and most importantly, Diewert (1976) has shown that the Törnqvist price index approximates to the second order of the underlying Konyus true cost of living index (Konyus, 1924); hence, by using the Törnqvist price index instead of the Laspeyres price index one can avoid the problem of substitution bias. Additionally, with the Törnqvist price index, the cost of living can be directly calculated using consumers' commodity expenditure shares and price ratio data without involving complicated econometric methods for estimating the related demand function parameters necessary to compute the corresponding Konyus true cost of living index (Jorgenson & Slesnick, 1999). Furthermore, unlike the econometric method, the calculations of the Törnqvist price index are not limited to broad aggregated commodity groups.

The adoption of an additively decomposed Törnqvist price index formula has two purposes. First, it allows us to identify and evaluate the contribution of each commodity group to the total growth of Taiwan consumers' cost of living over the study period. In many practical applications, we are not interesting in merely knowing by how much the level of consumers' cost of living has grown; we might want to go a step further to know how much each commodity group has contributed to the total growth in the cost of living and why some commodity groups have made higher contributions than others. …

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