Note: Descriptions are shown in the official language in which they were submitted.
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TITLE: A METHOD TO CALCULATE A MODIFIED CONSUMER PRICE INDEX
Field of the Invention:
This invention relates to ecomonic indicies and in particular to a modified
Consumer Price Index
(CPI).
BACKGROUND
DEMAND THEORY
In most cases of economic analyses, demand is described as a relation of price
and quantity
holding all other variables constant. Is it correct to hold everything
constant just to explore in so
many details all characteristics of only two variables and at the same not to
see the entire
picture? The following analysis of consumer preferences takes a different
approach. A new
variable is included but prices and a consumer's budget are being kept as
constant.
DETAILED DESCRIPTION
CA 02285165 1999-10-07
DETAILED DESCRIPTION
Price ratios, budget line and the third variable
According to the marginal rate of substitution, at certain price ratios (point
of tangency of an
indifference curve to the budget line), a consumer is willing to substitute
some quantity of one
good for a one unit of another. However, such substitution captures consumers'
preferences
only at a particular point in time. As a matter of fact, time is moving
continuously. It is the
third variable and should never be ignored.' How well then this theory holds
with respect to
time when prices and a budget are constant? For example as time goes by, a
consumer might
remain indifferent between purchasing rugs and purchasing paintings because
time is not a
factor. It is not the same when comes to bundles of goods called meals and
bundles of compact
discs. Assuming no other consumption, time changes discs for inferior goods.
More precisely, as
time goes by, the consumer is willing to give up discs at an accelerated rate
not only to obtain
additional meal (assuming that additional meals can be stored in the fridge)
but to begin
consumption of the original one. What happens here (on the graph), does the
consumer move
along the indifference curves or go on higher or lower ones? Movement along
any particular
curve implies indifference, higher or lower curves are results of changes in
prices or income. The
only explanation lies in the shape of these curves. The beginning of
consumer's awareness about
the importance of meals causes the indifference curves to move. Assuming meals
on a vertical
axis, the curves sooner or later must touch this axis. As time goes by, the
curves become flatter
and flatter. At a certain point, the consumer wants to give up the entire
remaining quantity of
discs since they no longer represent any utility. At that point the
indifference curves are flat lines.
Once the consumer begins to consume the meal, the indifference curves start to
go back to their
original shapes. The same process could be repeated over and over if the time
gaps between
each meal are that great. In reality, the consumer does not allow these gaps
to happen.
If the indifference curves are moving, do they intersect? By just looking at a
graph, a two-
dimensional picture and adding more and more indifference curves as time goes
by, a human eye
' In geometry time is referred to as a fourth dimension after height, length
and depth. Because only three
variables are analysed here, time is placed on a depth axis.
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detects intersection of these curves. In reality or virtual reality the points
of intersections are
actually the points of overlaps. There are time gaps between these curves.2
NOTE:
Technically speaking, the above example is not fully explanatory.
First, an assumption of non satiation (more of anything is always better)
which only refers to
the stock of goods, does not imply a full consumption at once. At certain
frequencies in time,
only specific quantities of goods are consumed (used up). Therefore, not all
indifference curves
change their shapes but only those which are close to the origin, those
attributable to a single
meal. With respect to time, an upper bound (called consumption) exists for
them and that
bound is a utility maximization point.
Second, "lexicographic preferences" could be a better explanatory method in
this particular
case. These preferences violate the assumption of continuity by imposing
restrictions to three
meals a day. Regardless of the number of discs, three meals a day are strictly
better than one
meal or five meals. However, time is continuous by itself. At the greater or
smaller fraction
than three, the consumer could still place the same value for the discs.
Finally, this example shaves the significance of time in a consumer's demand.
It does not focus
on indifference curves. Further and detailed analysis is beyond the scope of
this project.
This "time" example has two very rigid assumptions of prices and the
consumer's budget as
constants. However, the consumer's income as well as the budget might change
in time and so
the expenditures for meals. The budget constraint assumption therefore does
not apply well
when time becomes a part of analysis. It might not seem so in the case of
constant prices since
they are set by producers. But even this assumption is not fully accurate. At
no shortages in
supply, the consumer would still be willing to pay higher prices for meals
just to consume them
on time. A typical example is a situation where the consumer forgets to buy
groceries in a
supermarket during the day and pays higher prices at a 24-hour convenient
store.
Overall it should be remembered that it is rather easy but incomplete to
capture consumers'
preferences at a particular point in time, but it could become difl'tcult
however quite realistic to
This particular example could look very well in motion pictures but not so
good on a paper and therefore
graphics are excluded here.
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measure such preferences with respect to time. Time is an absolute variable
just because nobody
can stop it.
To better understand demand with respect to time, the following three sections
deal with
different types of goods. First section deals with those goods where demand
for them have
specific time constraints. Necessities, it is the right word for these goods.
They are simply
physiological needs of humans.3 In the second section, the demand for goods
does not have time
constraints at all. These goods are non necessities and are psychological
wants of humans.4 The
final section is about semi necessities which are goods that belong somewhere
in the middle.
Demand for necessities - needs
When discussing necessities, a reference to food or meals is the best one
since food is a number
one necessity and there isn't a slightest doubt that it is not. Since food is
a necessity then beef,
pork or chicken must be as well? The answer is no. Why? The demand for
necessities has
specific time constraints but the demand for beef, pork or chicken alone has a
budget constraint.
What it means is that a consumer may never eat beef because of taste, income
or a price of
chicken and therefore only eat a chicken. The exact opposite may apply to
other consumer.
However, both consumers eat three meals a day. All consumers eat three meals a
day. That's
why food is a necessity but any individual food items alone are not.
How then the demand for food can be expressed in a mathematical way (demand
function)?
It is not a function of price and quantity but time and quantity (three meals
a day, every day).
Why then the price is missing? The answer to it lies in understanding what
demand is. The
problem why demand is understood as a function of price and quantity has roots
in fundamental
economic principals (the law of demand). Generally speaking the law says that
at lower prices,
greater quantities of particular goods are purchased and vice versa. But this
basic law does not
Humans, it is the right word when physiological needs of people are discussed.
There must be a better term for non necessities. For the purpose of this
project however, the term non
necessities will not be substituted by any other term.
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apply to food. Demand for three meals a day exists even at higher food prices.
Why then the
price and budget constraint had always been such a crucial component of
demand? The answer
is very simple - the economic concept of scarcity. Budgets keep consumers'
demands reasonable
otherwise consumers would demand (without a cost) as much as economy produces.
This has
definitely some merits as far as the upper bounds of demands but what about
the lower bounds?
The lower bounds had never been drawn in economics. The reason for it can be
found in one of
the greatest error in economics and that is an error in assumption, the
assumption that people
must have money. As a matter of fact, people need money to pay the bills and
broadly speaking
can't live well without money. Fact however is not an assumption. Fact is only
a reality. What if
some people don't have money? That is a reasonable assumptions Certain goods
or quantities
will not be produced. But is this automatically means no money, no demands?
For example, if a
consumer can only afford a single meal in a given day why there is an absolute
certainty that the
demand for three meals exists? Because if the money is granted to pay for
additional two meals,
the consumer will not save such money but will buy and consume the meals like
everyone else.
Even millionaires consume three meals a day. Therefore when comes to
necessities, people or
humans have the same or identical demands and money is not an issue. What are
these
necessities? They are food, shelter, clothing and footwear, transportation and
hygiene products.
There are other necessities such as water and electricity. Water had always
been a necessity but
electricity became one.6
Are time and quantity the only variables in demand functions for necessities?
The answer is no.
The demand for clothes depends on an outside's temperature and temperature
therefore is a
variable. To write down specific demand functions for necessities could be
tricky. For example
transportation, at a very specific time during the day people need
transportation to get to work.
How then transportation should be expressed in terms of quantity as far as
interrelations of a
vehicle and distance? The greater the distance, the greater the needs for a
reliable, punctual and
That's also a fact but even this important fact was never analysed in
economics. Also, the fact that the
demand for three meals a day, every day exists, is really based on assumption,
an assumption that the time will
never stop since the demand for meals depends on time. Once the time stops,
the demand for food disappears.
The assumption that the time might stop is unrealistic and there is no need to
justify any further an original
assumption.
Why certain goods become necessities is explained in the semi necessities
section. Also, electricity as a
necessity means that people need lights in order to see when staying up late.
CA 02285165 1999-10-07
fast means of transportation. But these reliable, punctual and fast means
belong to psychological
not physiological needs and are beyond definition of necessities. It could be
hard to express
them mathematically. In this project it will not be important to know the
demand functions but
to understand what demand for necessities is all about. Demand for necessities
is about time.
Mathematically speaking, time is the independent variable (input numbers for a
function) and
quantity a dependent variable (output numbers for a function) in a demand
function for food.
Price is missing because quantity demanded depends only on time. As time goes
by, the quantity
demanded is not affected. This can be easily verified from food consumption.
At higher food
prices, consumers would not wait for them to come down but buy whatever
quantities are
required and that's simply true. On the other hand, all those consumers
without money would
still demand food at zero prices (free). But the overall result cannot be zero
since time and
quantity are never zero. That's precisely why, time and quantity are the only
variables in a
demand function for food. The exact opposite occurs for beef, chicken or pork
(non necessities)
as mentioned earlier. These demand functions have two variables: price and
quantity. Time is not
a variable even though everything happens at some point in time.' At the
elastic portion of the
demand curve, price is an independent variable. When "taste" takes priority
over price changes
(an inelastic portion), quantity becomes the independent variable.8
Demand for necessities is constant and continuous. As time goes by, the
physiological needs of
humans don't change and demand doesn't go up or down, it is the same. Such
constant and
continuous demand will be a key factor in the Consumer Price Index analysis.
But for now two
crucial things about necessities must be remembered. First, the demand for
necessities has
specific time constraints and the demand for non necessities budget
constraints. Second, people
don't need to have money to have demands for necessities and that's economics.
Technically speaking that's not correct because for non necessities, the
occurrence and duration of
demand depend on the recognition of price, duration of that price plus other
psychological factors of consumers.
For the sake of simplicity it is OK to say that price and quantity are the
only variables here.
This will be explained in the semi necessities section.
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Demand for non necessities - wants
This section is about consumers. Who should be classified as consumers? For
sure people who
have money but from non necessities point as well, all those who can afford
necessities and
much more.
The most characteristic feature about non necessities is an ambiguous process
of consumers'
decisions which results from abundance of available choices and alternatives.
There should be no doubt that unlike food, compact discs are non necessities.
They simply fall
into a category of psychological wants and pleasures.
The following non necessities' example is a long one but it shows quite well
what demand for
non necessities is all about.
If there is a consumer who has a CD player and one thousand discs and thinks
of buying
additional nine discs, what factors does she or he consider? It should be
mentioned first that the
ratio of one thousand to nine, existing to new discs had been carefully
chosen. Such a ratio is
simply at the edge of a propensity to consume, not a sharp edge of one
thousand to one but still
the edge. So, if the consumer would like to add nine more discs to already
such large collection,
it is simply a matter of quantity, but to be more specific, what if the
consumer wants to buy all
nine symphonies of Beethoven (one symphony on a disc) performed for example by
the Toronto
Symphony even though the consumer has these symphonies however performed by
the Montreal
Symphony? Will there be a difference in interpretation, how much difference?
What does the
consumer like more, Beethoven or the Toronto Symphony? If the answer is
Toronto Symphony
then the consumer should perhaps look among one thousand discs to find
symphonies by other
composers played by the Toronto Symphony and enjoy the music without
additional
expenditure. If the answer is Beethoven then the consumer should be satisfied
with the Montreal
Symphony. But if the consumer appreciates the music of Beethoven as equally as
performances
of the Toronto Symphony (even if for some unknown reasons there aren't in the
entire
collection many compact discs combining these two), then the consumer still
has a great
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dilemma of demanding only the difference but facing to pay a full price for
the discs. This type
of demand could be called a marginal demand. In this particular case of
marginal demand, the
consumer doesn't know the utility maximization point and hesitates to buy the
discs.9 There is
some good news to it. From time to time compact discs are offered at
discounts. The consumer
doesn't know when nor how much however can wait for prices to come down and
then decide
again. In the meantime, a salesperson approaches the consumer trying to sell a
cellular phone
just by saying that it's time to diversify the taste and enjoy the full value
of the product (the
consumer never had a cellular phone before). The salesperson understands that
the consumer's
demand for discs is marginal and is quite optimistic about the "shift" from
the marginal demand
of one product to a full demand for another product.'° That's not
everything. Another
salesperson sells stocks and bonds and thinks that it isn't a bad idea to wait
for discounts on
discs. This salesperson tells the consumer how great returns on investments
are and advises to
invest now and when discs are on sale, withdraw only a required amount from
the original
investment, retain the rest and still earn an interest. The consumer hesitates
because in a long run
the price of discs goes up however, likes the idea of investing.
In this particular case the consumer can only make a single choice. Buying
discs, a cellular
phone and investing the money all together means, consuming only a single meal
a day for an
entire week and that is not a rational decision.
The classical music lover can take time and carefully choose the best deal
because time in this
case is not a factor. It might not be so if a consumer is a pop music listener
and also has one
thousand discs and plans to buy few more. Such a consumer could place the
highest value for
the latest hits and waiting for discounts means compromising and buying
classics. This consumer
also thinks of buying a cellular phone and investing the money but all
together faces a different
dilemma. Among one thousand discs there are many oldies which no longer bring
satisfaction as
Marginal demand can be defined as positive expectations in the rate of change
in marginal utility
resulting from demanding additional, not identical but a similar product (or
the difference in that product), after
the difference in prices of both products is calculated and the original
product can still be consumed.
In the case of discs, even a small increase in marginal utility can be offset
by frequent listening to symphonies.
'° The term shift in demand is going to be used differently here than
it is used in economics. Shift in
demand will refer to the shift in a focus of attention.
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do the latest hits. But even the latest hits will soon become classics. The
decision therefore must
be made quickly because time is a factor here. Someone could be inclined to
say that the demand
for these discs has specific time constraints, the same as necessities. That's
true with one major
exception. The consumer does not have to buy them. Therefore, specific time
characteristics
not constraints, is the appropriate term for non necessities.
Unlike necessities where demand is continuous and solid, the demand for non
necessities is not.
It can appear and disappear as in the case of a pop music listener and if
marginal (the classical
music listener), is subject to captivity by salespeople.
What hasn't been mentioned yet is that changing demands which are so
characteristic to non
necessities contribute to complexity and quality of life. If necessities can
be described from the
point of cost of living, non necessities make up the standard of living.
Understanding demand for
non necessities could be difficult and only advanced topics may cover the
material thoroughly.
Demand for semi necessities
There should be some system classifying necessities and non necessities
because certain goods
create problems. For example appliances such as refrigerator or stove, if it
is necessary to store
the food and cook the meals, are appliances necessities? What about a haircut,
is it a matter of
fashion or hygiene? Umbrella, if it protects the body from getting wet, does
it serve
physiological needs? People can't live without money so must have wallets to
carry them? At the
end comes bread, eggs and milk. Why most people buy them regardless of price?
It is impossible to classify all goods into two categories without a doubt.
There are thousands of
goods which belong somewhere in the middle. A reference to them as semi
necessities is the best
solution. It takes critical thinking to find out what these goods are.
However, it can also be done
in a real life experiment. Such experiment could be difficult but achievable.
Several consumers
would be given lots of money but asked to spend only a bare minimum on
necessities and not to
spend on anything else if possible. As time would have gone by, some consumers
could not
resist and start spending on other goods. The important part of it is to know
the chronological
order of expenditures with respect to time because further and further they
can be postponed,
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less and less of necessities the goods are. The point of it is to prove that
semi necessities are not
equal because they are not bought at the same time. They are simply a creation
of a growing
standard of living. With comfortable and growing budgets people repeatedly buy
them, later
depend on them and can't live without them. The dependency on semi necessities
for a long
period of time is therefore a creation of necessities. How much is needed to
live, is really a
question where do people live. In a civilized world a phone or a watch can
"practically" be
called necessities because 95% population or even more have them. The best
example however
is electricity. Now electricity is not only a necessity alone but also a
commodity which cannot be
excluded from the use of appliances. But even in a civilized world there is
poverty and people
have to live on tied budgets. Such people could be a good indication how to
draw the line
between necessities and semi necessities however, their budgets are not the
same and in many
cases, demands could exceed budget constraints. Good intuition and abstract
thinking is perhaps
the best guidance to understand the difference.
Another category of semi necessities goods are those which will never become
necessities. Food
items such as bread, eggs and milk belong to an important group of this
category. It is crucial to
notice here that there are no substitutes for water and electricity, that's
why they are necessities.
Also there are no substitutes for food but unlike water or electricity, food
is an aggregation of
items which to the certain extend, substitute and complement each other. If
for example the
price of bread goes up, a consumer might substitute bread for rice or
potatoes, but how
convenient these substitutes are? If the consumer is only able to maximize
utilities in terms of
meals (necessity) but unable to maximize utilities in terms of taste (non
necessity), are such
substitutes satisfactory? Definitely not because most consumers pay higher
prices for bread
because are not willing to forego consumption of bread. One major reason for
it is the growing
standard of living where bread becomes more and more affordable and therefore,
the demand for
bread does not disappear in time. That's why bread should be considered as a
semi necessity.
Only very high prices can cause a shift in demand from bread to other goods.
Someone may still
ask why beef, pork or chicken are non necessities if consumers are unwilling
to forego them
because standard of living goes up? It is a very good question and it's hard
to give a straight
CA 02285165 1999-10-07
answer. Beef, pork and chicken can be all considered semi necessities because
consumers never
eat bread only, but meat as well. However, the price of bread is much lower
than the prices of
meat. Higher bread prices may not affect quantity consumed but higher meat
prices may
encourage consumers to look for other solutions to a good, affordable meal.
Why lobsters,
oysters and caviar are not necessities?
The most characteristic feature of semi necessities is time and quantity as
independent
variables and price as a dependent variable in a demand function." To explain
this differently,
there are two ways to do shopping. First is to take for example $100 and shop
around for deals
and discounts. Second is to list all goods needed to be bought, take the
money, go out and buy
them. In a first case price is the independent variable because quantity
demanded depends on
price or, the demand is for the right price. Time is not significant and at
high prices, nothing
might be purchased. This is very true with non necessities. In a second case
the demand for
bread, eggs and milk for example is actually a demand for specific quantities
of specific goods at
specific time. The demand curve for semi necessities is therefore inelastic.
More inelastic the
curve is, more of necessities the goods are. The exact opposite occurs for non
necessities. More
elastic the curve is, more of non necessities the goods are. However, the
demand for non
necessities can be inelastic as well. That's true but why? It only depends on
consumers' budgets.
Time constraints can play a key role in identifying non and semi necessities.
CONCLUSIONS
If price can be excluded from the concept of demand then what really is
demand? Is it anything
more than a recognition of needs and wants and the desire to consume and enjoy
goods which
satisfy these needs and wants? The acceptance of such definition creates
implications. The basic
economic principle of supply and demand express the interests of consumers and
producers in
one very universal way and that is the language of money. The concept of
demand however
" Unlike necessities, the demand for semi necessities has a price and that is
a sharp line of distinction.
Also, the demand function for semi necessities is a consumption function for
necessities. Consumption of
necessities occurs at cost.
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becomes more complex when time replaces price in necessities and could become
even
ambiguous by adding more non monetary factors to it. If demand is indeed a
recognition of
needs and wants then is it correct to call demand what is known as the demand
curve?'z It's
easier to answer this question by explaining why the word demand should not be
used for this
curve. For example, if there exists an economic entity with high poverty and
some people can
only afford a single meal a day, is such economy in equilibrium? Definitely
not because supply of
single meals does not intersect demands for three where in fact the
equilibrium is.'3 If people
consume only what they can afford and suppliers take into account such afford
ability, is
consumption the better or the right word for what's known as the demand curve?
There is a
very strong assumption in favour of consumption. People don't buy goods and
not consume
them because otherwise, it would simply be uneconomical.'4 To say that in a
simpler manner,
goods are supplied for consumption. Also in a general and aggregate sense, at
higher prices less
will be consumed and vice versa. This very much resembles the fundamental law
of demand.
The remaining question is how demand fits in the entire picture if there are
only two curves:
supply and consumption?'S The complexity of demand can make it hard to
graphically explain it
but it's there and will be there. It is a set of different signals which may
or may not trigger an
interest and response of suppliers and producers. An understanding of demand
means an
understanding of economic foundations.
This section closes with a new economic joke just to justify one more time why
consumption is
the right word for what's known as the demand curve and demand being a wrong
word.
Question: What is the difference between consumers and humans? Answer:
Consumers are all
those who have money, humans are all those who have demands.
'z Non monetary factors are also present in supply but all goods are supplied
only and only at cost and to
simplify this argument, supply is assumed to be the right word for the supply
curve.
'3 This work does not lead to anal sis of conditions for
y equilibrium. It is now obvious that demand, supply
and consumption of necessities must be in harmony in order for an equilibrium
to exist.
'4 Is acquisition of goods a process of demand or is it a beginning of
consumption? It is not physical
consumption but once consumers incur the cost, the consumption is assumed to
happen.
'S The consumption curve overlaps the supply curve because of the time gaps,
first goods are produced
then consumed.
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CONSUMER PRICE INDEX
In this part, the demand theory with respect to time will be used to question
the existing
methodology of the Consumer Price Index. Before getting into the index, a new
look at
definitions and concepts first, is imperative to understand the full idea of
price movements and
how all of it fits into the CPI. The analysis of the index provides
recommendations for a change
and should be looked at with an objective criticism just because there are
real issues there and
the stakes are high.
What is a pure price movement?
Statisticians measure pure price movements by taking into account all
improvements made to
the products which are being measured. Pure price movement is therefore a
price movement of
the same product from one period to another. This concept however is only a
tangible one.
There are many intangible features causing prices to move. These features
significantly
overwhelm the tangibility concept because they are the real sources of price
movements. In this
section (because it is about the CPI), only those features applicable to
consumers are going to be
examined. Supply of goods and monetary policy are assumed to be all right.
Demand
As mentioned in a non necessity section, consumers' demands are changing and
appear and
disappear in time. It all results from a volume and variety of choices
available to consumers in
the market. The velocity of shifts in demand and the duration of demands will
never be known
since they happen in consumers' minds. In many cases it is incorrect to say
that at very low
prices demands still exist. The pop music listener had technically speaking
free discs to satisfy
musical pleasures but still considering to buy the brand-new stuffi On the
other hand, higher
prices may not affect quantity demanded because if the classical music
listener buys a cellular
phone, such a consumer can only identify a level of personal desire and match
that with the
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asking price. If this is a first cellular phone, the level of such desire is
high and the consumer
probably doesn't know historical prices of the phones which could be lower.
In general, retailers don't know what's happening to consumers' demands but a
lack of response
from consumers causes prices to be adjusted accordingly, prices therefore go
down. Prices can
also go up if consumers too often make impulsive expenditures due to sudden
fascinations.
Demand is perhaps the most important intangible feature which explains price
movements.
Timing
A silence from consumers is not necessarily a signal to retailers that the
demand for a product no
longer exists. The consumers' comfort of postponing expenditures has an effect
on price
movements. Consumers simply wait for prices to come down and buy when the time
is right.
But waiting can also backfire. If too many consumers enter the market for a
product at the same
time, the prices can rise because there will be shortages in supply. The real
source of the reason
in this case is not shortages but bad timing and timing, is an intangible one.
Savings
Changing propensities to save has the same effect on prices as timing. Saving
is a fixture's
consumption. The so-called lack of consumers' confidence sometimes is nothing
more than a
growth in savings even when there are no layoffs and the incomes don't change.
Why necessities?
It is very obvious that all intangible features of price movements apply only
to non necessities.
No human saves money by cutting on meals, no human waits for the right time to
buy them
because, the demand for three meals a day exists and will exist. Necessities
therefore should
become a focus in measuring inflation because the concept of pure price
movements applies to
them. With necessities many technical problems can be eliminated right from
the beginning.'6 It
is practically impossible to do that with non necessities. There are always
going to be intangible
movements. What about semi necessities, do they create problems? The answer is
yes and no but
the food section in major components will explain the phenomena about semi
necessities.
'6 This is only a general idea because to measure price movements for meals,
one must measure prices of
food items which are semi and non necessities. It will be explained later.
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Inflation, deflation, a problem of inflation and a problem of deflation
Traditionally speaking, inflation and deflation are the end results of reasons
causing price
changes even if all the reasons are not necessarily known. This general
concept includes all the
goods and services produced in the economy. But more specific terms could be
used to address
price movements for necessities and non necessities. These terms will not be
brought here.
Instead, the notion of "a problem of inflation and a problem of deflation"
will be evaluated. For
example, if the price of compact discs and the food prices go up, the word
inflation comes in as
an explanation for both. If consumers pay those prices, is there a problem of
inflation in both
cases? Consumers don't have to pay higher prices for discs but they want and
they do. On the
other hand, consumers may not want to pay higher prices for food, but they
must. These two are
not the same inflations because there isn't a problem of inflation when comes
to discs since
consumers voluntarily pay higher prices for them (assuming that they know
about it), but there is
a problem of inflation when comes to food prices since consumers can do
nothing about it. So,
the problem of inflation applies only to necessities because of time
constraints. What about a
problem of deflation, is it simply an opposite to inflation? The problem of
deflation occurs
because there are no time indicators when non necessities have to be purchased
when their
prices keep going down. Technically speaking however, it shouldn't be a
problem since
consumers are simply taking advantage of lower prices in the fixture." The
only real problem of
deflation is a scenario when consumers trade necessity goods between
themselves knowing that
prices of these goods will be significantly lower in the fixture and therefore
keeping money in
saving accounts. However, this situation is highly unlikely to occur in
today's world.
Unfortunately, it is a problem in macroeconomics.
CA 02285165 1999-10-07
CPI analysis
WEIGHTS
Weights are the reason why CPI requires changes.
This part focuses on weights.
Why?
What if all goods in the Consumer Price Index can be classified as
necessities, semi necessities
and non necessities or to make it simpler, necessities and non necessities?
What if consumers
spend SO% on necessities and 50% on non necessities? What if there is an
inflation of 5% for
necessities and -5% for non necessities (deflation of 5%) or vice versa? The
Consumer Price
Index will read this as 0% inflation (no inflation). Is that correct?
In a big picture it might seem correct because the existing methodology
applies weights which
come from surveys of family expenditures. It is not correct since measuring
non necessities'
prices means not measuring pure price movements. But that's not all, there is
something more
important which makes the entire system very vulnerable. If for example
individuals save or
invest money for future's consumption (long term investments), do they know
what exactly will
they spend on? Not exactly but for sure on necessities since the demand for
necessities depends
on time and does not disappear. More, most individuals save much less than
they earn and
according to a forward- looking theory of consumption, when these individuals
become seniors,
they might not be able to maintain the same standard of living as they did in
the past when being
employed because of a dependency on fixed incomes. The type of standard of
living fixed
income people face can be hard to estimate. The only way to do it is to
measure existing
expenditures of seniors and then apply weights accordingly. However, this
excludes all those
who are saving for their retirement now while being in a labour force and have
many years ahead
before becoming seniors. Therefore, it is impossible to know the future's
weights. That's
16
CA 02285165 1999-10-07
perhaps why the present methodology does not address the future at all. It
cannot really do that
because the weights are unknown or they have to come from somewhere. The only
thing which
remains certain is a demand for or a consumption of necessities. So, if
necessities have 5%
inflation or 5% deflation, is it correct to say that the inflation rate is 0%
since non necessities
make up the other 5%? The answer is no because such an inflation rate does not
apply to
savings or investments. At continuing 5% deflation for necessities, seniors in
particular will
benefit from lower prices in the future but keep losing at 5% inflation. To
leave the existing
methodology without a change is just risky. It is better to make changes now
because there are
only modest price movements in the Canadian CPI. Not doing anything now could
mean dealing
with unknown in the future if the price movements become uncommon.
But how to make any changes if the future's weights are unknown? The remaining
of this
project is about solutions to a "rate" problem for savings and investments. A
core solution to it
is a Consumer Price Index for necessities only. This rather simple and
straightforward index will
have advantages of pure price movements.
One indez versus two indexes
If any CPI measures price movements for necessities only, it is technically
speaking a new CPI.
What should happen to the existing one?'8 The question here is whether or not
an index for
necessities only, satisfies the "all purpose" requirements. The simple answer
is no because not
knowing the trends in non necessities' prices means not knowing the trends in
demands for these
goods. But such trends are not an indication of inflation because demands for
non necessities
change and prices together change as well. However, a continuity of the non
necessities' index
might bring other benefits besides the traditional quote of the inflation
rate. Therefore, this index
should not just disappear.
The CPI for necessities only, could solve the rate problem for savings and
investments. But
would such an inflation rate also apply to employment contracts and wages?
From the CPI point
alone however, there is a tremendous difference between savings and wages.
Weights are the
'g Just to mention that the weights of the existing CPI do not apply to
savings but the weights of a new CPI
would have to come from somewhere. The question of weights will come back
later.
17
CA 02285165 1999-10-07
difference. From one year to another, wages of workers do not fluctuate much
which means that
most full time workers earn almost the same money in two subsequent years.
They are a typical
example of CPI expenditures - weights and (with an assumption of error) might
continue to buy
the same non necessities goods. If these workers spend SO% on non necessities
and 50% on
necessities, how should their wages be adjusted in a case of 5% inflation for
necessities and 5%
deflation for non necessities? It seems at first that there is no need for an
adjustment of wages
since most workers make the same expenditures from one year to another.
However, there is an
issue of savings or a propensity to save. That percentage of income should be
definitely
adjusted. As a result of it, wages should go up slightly. But this is only a
theory and it may not
work at all in a real life. Paying 5% more for necessities could mean not
having this 5% to pay
for other goods since an adjustment of non necessities' prices might be
strictly related to a lack
of money and therefore, lower prices for non necessities do not reflect their
cost and value. If on
the other hand goods are bought on credit, 5% deflation for non necessities
can be a result of
shifts in demands for a better quality goods and measuring current prices of
once highly
demanded goods might be an explanation for deflation which is in reality an
obsolete data. So,
there is a strong possibility that in a case of 5% inflation for necessities
workers could demand a
5% wage increase just because price movements for non necessities are not a
good indication of
real prices and trends in expenditures. The great controversy however could
happen in a case of
inflation for non necessities and deflation or no inflation for necessities.
If there would be no
inflation for necessities but 10% inflation for non necessities, should
workers receive a 5% wage
increase?'9 In this particular case the employers could make a point. The
point is why would
anybody knowingly pay higher prices for non necessities and then demand higher
wages
accordingly? Isn't it better to take more time and shop around for deals? The
response of
workers would be simple. They work hard for their money and everything they
don't want to
buy is cheap, but everything they do is expensive.
19 The 5% upward shift in an inflation rate instead of 5% deflation for
necessities and 5% inflation for non
necessities, helps to explain the controversy of wage increases better since
the debate focuses on a 5% increase.
18
CA 02285165 1999-10-07
The controversy of wage issues goes beyond the scope of this project. The
existing CPI could
become vulnerable every time a noticeable discrepancy in rates between
necessities and non
necessities occurs. This applies to wages as well as savings.
Would then an inflation rate for necessities only, be sufficient for the
purpose of wage
negotiations? The intuitive answer is yes because it would only be a major
indicator of the
direction in wage adjustments, it should never be an automatic, full
adjustment by itself.z° Also,
the significance of necessities and their price movements is too prominent to
treat it equally with
non necessities. Above all, wage negotiations go far beyond statistical
information and inflation.
They consist of factors directly related to the performance of businesses and
these factors might
be the key issues of attention.
The most important reason why non necessities should not be measured for the
purpose of an
inflation rate is a scenario of higher non necessities than necessities'
prices. As a result of it, the
overall inflation rate would go above the necessity rate (assuming substantial
expenditures for
non necessities) adding to the cost of borrowing money. If people's demands go
up which shows
in higher prices then why should this add to the cost of borrowing money?z'
The entire economic
growth depends on the cost of financing. It is OK to measure price movements
for necessities to
protect the cost of living but it is not OK to protect the standard of living.
Wouldn't the best
alternative of protecting standard of living be through economic growth and
prosperity which by
itself brings a higher standard of living? Should concerns of higher prices
for non necessities
become a thing of the past?zz
Weights for necessities
The above argument about necessities and non necessities has its roots in
weights. Why in
weights, here is an explanation. In 1938 expenditures on food accounted for
31% of Canadian
zo ~ automatic, full adjustment is indeed appropriate for minimum wage jobs
but not for high paid
professions. However, that is true in a case of inflation because in a case of
deflation, an adjustment of minimum
wages for even lower wages (assuming no regulations) would cause labour
disputes.
z' How raising the interest rates in this case can be explained, is this
fighting inflation or fighting demand?
22 Is traditional method of fighting inflation too costly in today's highly
developed world?
19
CA 02285165 1999-10-07
family's total consumption. In 1967 expenditures on food went down to 24% of
total
consumption and in 1996 down again to 17%.z3 Over the years weights for food
are steadily
going down and that creates a real problem. If for example visitors from
another planet would
come to visit earth, by reading the Canadian Consumer Price Indexes they could
conclude that
as time goes into the future, humans demand less and less food but more and
more readings and
recreation. Why they should draw such conclusions? Because if humans apply
lower and lower
weights to food, food automatically becomes less and less significant price
movement to them.
That's wrong. Price movement for food is the most significant price movement
now and in the
future and therefore, food should always have the highest weights. That's why
an argument
about necessities and non necessities has roots in weights since the
continuation of an existing
methodology could bring even lower necessities' weights in the future. But in
order to apply the
highest weights to food, weights for other goods must come down or some goods
must
disappear from the index. Non necessities will disappear to give the way to
necessities.
Where should the weights for necessities come from?
The existing application of the CPI weights is based on the surveys of family
expenditures.
Higher expenditures on goods reflect in higher weights for these goods. This
method can be
called an expenditure factor method since weights purely reflect expenditures.
The problem
with this method is the growing standard of living which ultimately results in
lower weights for
food as already mentioned. However, the expenditure does not mean the cost. If
for example
people spend more time with their computers, the overall hydro bills will go
up since more
electricity is used but the cost of electricity expressed in kilowatt-hours
may remain the same.
With respect to necessities the cost is what really must be known in
application of weights. It
also means that for the purpose of weights, consumption of electricity should
be narrowed to
z3 Sources:
1. Dominion Bureau of Statistics, Prices and Price Indexes, 1913-1940,
Catalogue no. 62501, Table 22.
2. Dominion Bureau of Statistics, Urban Family Expenditure, 1967, Catalogue
no. 62-530, Table 1.
3. Statistics Canada, Family Expenditure in Canada, 1996, Catalogue no. 62-555-
XP B, Table 17.
The estimated numbers were calculated by applying 100% to the total current
consumption.
CA 02285165 1999-10-07
necessities' consumption using electricity's cost as a base. By doing this all
non necessities'
weights are eliminated. This approach can be called a cost factor method.
However, the demand for necessities has specific time constraints. Should the
time also be taken
into consideration? If the answer is yes then how to account for time when the
demand for all
necessities has equal time constraints which means that physiological needs do
not discriminate
or that the recognition of a lack of any need automatically triggers demand
for that need? Even
though the demand for all necessities is equal with respect to time,
necessities by themselves are
not equal. Why food is a number one necessity, becomes obvious just by going
back in time as
far as possible, as far as the beginning of human's existence. Why electricity
is not a number one
necessity also becomes obvious by going back in time. This simple exercise is
a good guidance
in defining the difference between deep core and shallow core necessities. It
can be used for all
necessities. So, to take time into consideration when weights are concerned,
the length of time
of existence of any particular necessity should be an indication for the
weight. This is a time
factor method in application of weights. Deep core necessities should
therefore have higher
weights than shallow core necessities.
If the cost and time factors answer the original weights' question, this still
doesn't tell how to
combine these factors together. The problem is that it is impossible to do it
right for two
reasons. First, it is easier to numerically apply weights according to the
cost of necessities but it
is very hard to establish the time factor or a significance of any necessity
and then numerically
apply the weight. To say that in other words, how much more important is food
than electricity?
Second, if such importance can really be established, how then a time factor
should be combined
with a cost factor? What's more important, the cost or the significance of a
necessity or, are they
perhaps equally important? How should these relations be expressed
numerically?
There is no solution to this problem but it doesn't mean that the time factor
should be excluded
to make it simpler and accurate. Why the time factor is significant becomes
evident in the
following composition of weights for necessities. These weights are only
intuitive application
of numbers to the cost and time factors. Both factors are treated equally.
21
CA 02285165 1999-10-07
Food 37%
Shelter 30%
Clothing and footwear14%
Transportation 8%
Hygiene products 2%
Semi necessities 9%
The most noticeable thing besides the numbers is the inclusion of semi
necessities in the
necessities' weights. Now it should be clear why the argument about
necessities and non
necessities excluded semi necessities. Semi necessity goods such as food items
are included in a
food component but those independent ones such as watches and wallets are
included in their
own component. This is a necessity index after all because most semi
necessities belong to the
necessities' components. That's why they are called semi necessities. Only 9%
weights are
assigned to other semi necessities.
Water, electricity and natural gas are included in the shelter.
With respect to cost and time factors, there is no further justification of
the weight numbers
assigned to necessities. However, "major components" will reveal more about
necessities and
why a particular necessity weight number might be appropriate in comparison
with the other
necessity weight number.
The above weights could remain for as long as there is no further creation of
necessities
otherwise, they are only a temporary solution to the problem of growth in
necessities.
MAJOR COMPONENTS
Food
Is 37% a high number or a low number assigned to food? This number might be
just about right
because Canadian winter causes shelter's weights to go up. Shelter in Canada
is almost as
significant as food. In warm climates the shelter's weights could be lower but
the food's weights
higher. The climate addresses only a cost factor because the time factor is
identical for food and
22
CA 02285165 1999-10-07
shelter. It means that every human would like to consume three meals a day,
every day, and
sleep approximately eight hours every day. Food, shelter, clothing and
footwear are the deep
core necessities. All together, they take a very high percentage of the total
weights.
So far, three types of food groupings have been introduced. The first type
includes semi
necessities such as bread, eggs and milk. The second type includes beef, pork
and chicken which
are non necessities. The third type was mentioned only once. It includes
lobsters, oysters and
caviar. Those three groupings are sufficient to explain what food as necessity
really means. Food
simply means a daily survival. Lobsters, oysters and caviar are therefore not
only non necessities
goods, they are luxurious goods. Their high prices partly explain the reason
for the term. The
other and the real reason for these goods being known as luxurious lies in
quantities available to
consumers. These goods are scarce to begin with and therefore are not a part
of the daily meals.
That's because they are only supplied by people, however they are produced by
nature. Nature
does not produce enough for everybody anymore. It also means that people or
suppliers of these
goods don't have a total control over future's quantities produced. Changes in
supply of these
luxurious goods can further affect demand and prices. As mentioned earlier, a
pure price
movement concept assumed monetary policy and supply of goods to be all right.
The significant
lack of human control over renewable natural resources makes the entire
fishing industry
unsuitable to satisfy the concept of a pure price movement. For the purpose of
measuring food
prices as necessities, seafood goods should be excluded.
The remaining two types of food groupings also don't satisfy the concept of a
pure price
movement since according to the demand theory, only the food does. That's
correct but unlike
expensive seafood goods, these goods make up the daily meals. The composition
of daily meals
does not necessarily change over time. This means that statisticians could
tell without a
reference to surveys what people eat for breakfast. Coffee, tea, juices,
muffins, cereals,
pancakes, waffles, eggs, bacon, ham and toast would certainly be identified.
What are the
chances of these goods disappearing from the menu if they have been part of
the menu for a long
time? In other words, longer and longer the goods make up the daily meals,
more and more of
necessities they become. There is a chance that some items could disappear
once and for all
23
CA 02285165 1999-10-07
giving room for a better, healthier food products, however, it is practically
impossible that all of
the sudden consumers forgo the consumption of all existing breakfast goods in
favour for other
goods. In time therefore, the composition of a breakfast meal does not change
much. It might
not be quite the same with lunch and dinner meals since consumers' incomes
determine how
much beef, pork and chicken will be consumed. But if the quantity consumed is
not affected
from one period to another even if there is a change in prices of these goods
or a change in
consumers' incomes, it simply means that the change in prices or income
reflects a change in
expenditures on other goods because there is a strong taste preference for
beef, pork and
chicken. In such cases, it could be possible to measure the price of daily
meals since the
consistency of quantities is not affected by any other variables. If on the
other hand there are
significant shortages in supply, the composition of meals would change but
unlike the seafood,
people produce and supply beef, pork and chicken and therefore have almost a
full control from
the beginning to the end of a supply process. The total control in production
cannot be achieved
in grain products because of the dependancy on weather conditions. However,
the price of bread
is low and the demand does not disappear. It seems therefore that a compromise
must be taken
in order to measure pure price movement for meals. In reality there isn't a
pure price movement
just by itself because it wouldn't be a one in a first place if everything
else remained constant.
But the trick here is to know the factors causing prices to move and whether
or not it is possible
to deal with them.
Price movement for meals is an alternative to price movements for food. It
eliminates many
intangible variables which are characteristic to the consumption of food with
relation to the
standard of living and focuses on a necessity aspect of price movements. It
could be used as an
absolute price reference since such price reflects interests of everyone at
all times.
It should be obvious that consumption of meals in restaurants is not necessity
consumption.
Even if consumption of meals in cafes and restaurants recurs at every lunch
break, the continuity
of such consumption is not sufficient condition to consider this a necessity
because, eating out
has no time constraints whatsoever. Eating out therefore should not be
measured in a necessity
index.
24
CA 02285165 1999-10-07
Prices of fiuits and vegetables available only seasonally can be measured
because once they
become available, consumers take advantage of it and for that specific period
of time, adjust the
pattern of daily meals.
Special care should be given to agricultural subsidies. Subsidies in general
have political
foundations of keeping agricultural industry on a solid ground. The real issue
is not so much
about subsidies but a rate of change in price of any particular product as a
result of a rate of
change in subsidies from one period to another.
Only main issues were mentioned in a food component. The complexity and volume
of the
technical and practical aspects of the methodology make it hard to go into
further details and
that's why only a general idea has been introduced. Everything else might be
left as it is.
Shelter
What is location, location, location? It is a standard of living because there
aren't two identical
locations. Location therefore has always been a crucial identifier of that
standard. Location on
the other hand has nothing to do with shelter. Shelter means a place to sleep,
a place to rest. It
doesn't mean home, a backyard or real estate ownership. If the demand for a
place to sleep does
not change but the demand for location does, then how to measure inflation
with respect to
shelter as necessity when every shelter must have some location? The only
solution to it is the
exclusion of land from shelter. This leaves with construction costs of the
shelter which are the
only indicators of inflation. The inclusion of land could lead to pure price
movement errors since
it is impossible to account for an impact of drug dealers coming into and
going out from the
neighbourhoods on price movements or, an impact associated with employment
opportunities in
certain geographical areas. The exclusion of land will not reveal the true,
full cost of shelters but
this is not what measuring inflation is all about. It is about measuring a
rate of change. What
must be known in this particular index is the rate of change in the price of
shelter as necessity
but not the rate of change in the standard of living.
CA 02285165 1999-10-07
The best way to find out about shelters' construction costs is at the new home
developments.'
All costs are combined together and add up to a single price of home. A home
or a house is
what people buy. They don't just buy a shelter. This means that new homes
could include
swimming pools, recreation or exercise rooms. Changes in prices of new homes
could come
from changes in non necessities' costs. The way to deal with it is to
eliminate ornaments and
concentrate on bricks and mortar. Bricks are bricks whether they are used to
build the bedroom
or recreation room. It doesn't mean that an Industrial Product Price Index
should become a
better reference to construction costs, it means that the price of shelter,
not a price of home
should be defined. A construction industry uses a jargon of "square footage"
to define
construction costs. Such reference applies to any size of the shelter and
could be a better
alternative in tracing costs.
Because shelters are durable goods, only few people move-in to new shelters in
any year. This
creates a technicality problem because a total inflation rate for the shelter
component is derived
from only few prices of new shelters. It must be mentioned that what is really
being measured
here is actually a rate of change in opportunity cost for everyone living in
current shelters. Those
shelters will eventually deteriorate to the point that they are no longer
suitable for use and prices
of new shelters should therefore be everyone's interest. Someone may want to
make a point that
the deterioration process is slow and a life expectancy of a shelter is
greater than a life
expectancy of a human and therefore, prices of new shelters might be of no
concern to a person
who has recently moved-in to a new shelter. That is partly correct with two
major exceptions.
First is that an opportunity cost is continuous and no concerns to any
particular individual might
become some or even great concerns to his/her children and grandchildren.
Second, employment
opportunities become global and a job hunt no longer focuses on a
neighbourhood and vicinities.
That's why knowing the prices of new shelters should be everyone's either
direct or indirect
interest.
2a A definition of home as a shelter includes apartment buildings, detached
and semidetached houses, but
it excludes seasonal and recreational properties.
26
CA 02285165 1999-10-07
Measuring opportunity cost explains the rationale of the concept but it still
doesn't deal with a
problem of so few numbers for so many, 30% weights. If 7% of these weights can
be assigned
to water, electricity and natural gas since they are supplied to homes, then
remaining 23% are
construction costs. What if there are no new home developments in a certain
year? The only
solution to it is leaving the inflation rate for shelters blank or read it as
zero inflation. In a case
of very few developments, only low weights of 5% to 10% for example may be
applied. The
23% weights are appropriate if enough data are available to have a view of the
entire picture.
But the whole thing can still be controversial because prices of new homes
(technically speaking)
dictate the entire inflation rate for the shelter component. The only
alternative to offset an
impact of such data is to change the significance of shelter from 23% to for
example 10% in the
necessity index and redistribute 13% weights elsewhere because the next best
alternative is not
to measure shelter at all. It should be stressed one more time that the
concept of shelter is a very
unique one since it separates land from a building. The inclusion of land
leads to errors because
location is not necessity.
Clothing and footwear
Clothing and footwear is quite simple comparing to shelter. The line must be
drawn between
necessity and fashion and that's all there is to it. It may seem difficult
since all new clothes are
fashionable, conceptually however it is not because it's easy to understand
the difference. Since
all new clothes are fashionable, drawing the line becomes a challenge. The
objective here is not
to eliminate fashion completely but rather to identify fashion. If some
clothes and shoes are worn
on a daily basis, they can be considered necessities or precisely speaking
semi necessities. If a
dress for Saturday night is not suitable for any other day of the week, it is
not a necessity dress.
But the real challenge begins with professional attire, necessary in today's
workplace. The only
way to find out how to deal with this issue is from surveys since people's
intuition could be the
best indication what they understand by necessities and what they want to be
measured. Because
the issue of professional attire might be controversial, lower time factor
weights (in comparison
with deep core clothing and footwear necessities' weights) might be applied
here. The 14%
27
CA 02285165 1999-10-07
weights in a necessity index which seem to be high in relation to
transportation's weights, also
reflect physiological changes happening to humans until the age of maturity.
All sport's and recreational clothing and footwear should be excluded from a
necessity index. All
jewellery and other decorative items should be excluded as well.
Transportation
Why transportation's weights are so low (only 8%) can be justified by
explaining what
transportation as necessity really means. Transportation in general is a
method of relocating
people and merchandise from one place to another. Transportation as necessity
is a relocation at
specific time constraints. But transportation as necessity also means that the
primary objective of
transportation is relocation, therefore, transportation in this respect is not
a time saving device.
But what really transportation in today's world is? It is a major
technological progress affecting
enormously the standard of living in every household. Why then the weights are
so low when
expenditures on transportation are increasing? The weights are low because the
basic needs of
people don't change.zs What people really need, is a vehicle to relocate them
from homes to the
place of work but what do they get? They get air bags, ABS, power steering,
radio and much
more from the technological paradise. Is automobile industry of the private
sector unsuitable to
satisfy the concept of a pure price movement? The answer to this question
cannot be given alone
because in order to do that, other topics including public transportation must
be discussed all
together.
Transportation is a transition from a deep core to shallow core necessities.
Transportation does
not universally serve the purpose for everyone since seniors who may stay most
of the time at
home, or children who have (technically speaking) a walking distance to
schools do not require
transportation to the same degree as working adults. But even working adults
use different
means of transportation. Some of them prefer private transportation, but
others prefer public
transportation. The preferences for private transportation where public
transportation is
available reflect to the great extend a standard of living. The cost becomes a
secondary issue
since convenience and time savings take a main objective. But on the other
hand, public
zs )ust to mention that transportation of merchandise is excluded because this
is CPI and only the basic,
physiological needs of people are considered.
28
CA 02285165 1999-10-07
transportation is also convenient and saves time especially in large
metropolitan areas. On top of
that, public transportation gives the very basics of transportation excluding
all diversification of
products the car industry offers to individuals. It seems here that public
transportation is the one
which should be considered as necessity since it can well and uniformly
satisfy the fundamental
needs of many without any individual bargaining for price and product
position. This might be
considered true as far as large cities since the demand for such
transportation will not be
significantly altered even at the growth in standard of living because of
congestion problems in
cities, however, it is not true in small towns and remote rural areas. Private
transportation is the
only one there. The problem of defining private automobile industry as
necessity lies in the
continuous growth in technology. If a car can be considered the basic mean of
transportation in
Canada just because it is affordable and because there aren't any others, so
commonly
identifiable means as cars, then what is an affordable bicycle in China? Is it
a necessity or
recreation device? Because the main feature of necessities (beside specific
time constraints for
their demand) is a lack of substitutes, to what extend can a bicycle in Canada
be considered a
substitute for a car? To what extend fluctuations in car prices affect demands
for bicycles as far
as the concept of a cross elasticity of demand? Not much or hardly at all
because the demand for
cars is not so much a demand for necessities but a demand for a standard of
living. Why this
statement is correct, can be verified from living habits of people. People in
general prefer to
incur the costs of transportation just to be able to live in their dream homes
once such homes are
found. People or working adults do not locate close to their jobs and relocate
every time new
jobs are found. To say that in another way, the demand for standard of living
creates necessities
and transportation is a very good example of it. Transportation is not a deep
core necessity.
The above argument only explains why the percentage number for transportation'
weights is low
but it doesn't tell what should be really measured and how. The reason for it
is that
transportation is the most difficult component of all just because it is hard
to define as necessity
and because technological progress by itself creates necessities. For
practical reasons, both
private and public transportation should be measured. There is no golden rule
as to the
methodology therefore, an assumption of error must be admitted. In general and
with respect to
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pure price movements, only deep core necessities are relatively easy to
measure because further
away one goes, a higher probability of errors occurs. This underlines that
measuring price
movements will never be perfect due to complexity of the concept. Applying low
weights to
transportation is also a way to minimize an overall error making the entire
inflation rate a more
reliable source of data.
Hygiene products
Hygiene products component is similar to clothing and footwear. The line must
be drawn
between hygiene products and cosmetics. Low weights reflect mainly low
expenditures on these
products. Due to a striking similarity between this component and clothing and
footwear, no
further comments are included here.
Semi necessities
These are actually new necessities which haven't been included in the index
yet. They became
necessities as a result of growth in the standard of living. The surveys of
family expenditures can
identify what these goods are. If 95% of population or more have them, then
these goods should
be measured. The surveys should also ask which goods people think should be
continuously
measured and which can be skipped. If for example most households have
television sets but
there is a great chance that the technology of television might be combined
with a computer
industry, people may not be concerned with the current TV prices. On the other
hand, they may
want to know the prices of refrigerators on continuous basis since there isn't
anything new
coming in the refrigeration industry which in a near future could substitute
current refrigerators
completely. But there is one thing which shouldn't be asked from people and
that's an
application of weights to those measured goods and the application of weights
in the entire
index. The problem could arise once people start applying for example 30%
weights to this
(semi necessities') component just because they think of the goods as
expensive. This would
create a problem of giving more weights to semi necessities (or shallow core
necessities) and at
the same time, taking away weights from deep core necessities. As a result of
it, price
movements for refrigerators for example would start becoming relatively more
significant than
CA 02285165 1999-10-07
price movements for food if the refrigerators' prices keep rising on
continuous basis but food
prices don't. This would result in going back to a current system of applying
the expenditure
factor into the weights.
However, the biggest concern about the semi necessities' component lies in the
problem of
growth in necessities. The weights in the necessity index do not address this
problem. They only
show how dii~erently understanding and measuring inflation can be. The
continuous growth in
necessities would force an adjustment of weights in the entire necessity
index. That's why
weights are so crucial in the entire methodology and will probably receive a
great focus of
attention in the future.
Non necessities components
This section explains very briefly why certain components are not considered
necessities and
why they are missing in the necessity index.
Health care
It might be the most controversial issue whether or not health care is a
necessity. Once people
get really sick, the physiological needs for a cure become the most essential
needs. In this
respect health care can be considered necessity. There are many reasons why it
is excluded in the
necessity index. A very practical reason is that health care in Canada is
provided at the public
not a private sector which means that consumers pay only a small portion of
the entire cost from
their after tax incomes. The inclusion of even a small portion of private
expenditures on health
care in the necessity index could create misunderstanding what inflation
really is. In the case of
no overall inflation, could inflation for health care alone be a reliable
signal to raise the interest
rates? The science of health care becomes more and more a science of
immortality. How should
the demand for immortality be assessed with respect to money? Fear of death
creates demand
for health care, but fear is a very psychological, not physiological feature.
Also, expenditures on
health care do not only occur at the time of sickness but they have a
preventive approach and
that makes the difference in individuals' wants. The demand for health care
therefore is easy to
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CA 02285165 1999-10-07
define at the time of sickness but it is not during the health of individuals.
The biggest reason
why the cost of health care should not be measured at all is the direct
contribution of technology
into the benefits and progress in health care. Because of that, the entire
cost of health care is
immeasurable with respect to benefits derived from it.
Education
It is not a necessity since there are no physiological needs and no time
constraints for education.
If all kids start to go to school at the age of seven, it does not explain why
they don't do so at
the age of ten. Education is very habitual and intellectual aspect of life.
Household operation and furnishings
Certain items as beds, sofas, tables, chairs, appliances and few others might
be included in the
semi necessities' component. Overall, these goods are rather expensive but
they also have long
life expectancy (25 years for appliances). Because of that the weights are low
and there is no
need (in this project) to include these items in a separate component. It must
be mentioned that
many people buy new furniture from a perspective of interior home design and
fashion even
though still having used ones to serve their basic needs. These types of
buying habits are nothing
more than a marginal demand and they should be taken into consideration. The
rest of the
household operation and fixrnishings component includes non necessities.
Readings, recreation, tobacco and alcohol. These are clearly non necessities
components.
SUMMARY
The Consumer Price Indez part and even the demand theory were barely
introductions.
Only the key issues were introduced to create a framework for more analyses.
There might be
thousands details there which need to be worked out and explained. But the
focus of the entire
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CA 02285165 1999-10-07
project was on a main idea, an inclusion of time in the demand theory and
applying that theory
into the CPI. This gives new foundations for further studies by economists and
statisticians.
As the demand theory showed, analysing three variables brought new arguments
and new
results. If in the future economic analyses more variables can be included, an
understanding of
demand will flourish. Psychological features such as fear, greed, jealousy,
ignorance or fun
might be in some cases the most prominent ones affecting demands and they
should not be
ignored. It seems that analysing all at once in some economic concepts might
be the better way
to go than analysing only certain fragments and keeping everything else
constant. The
complexity of demand cannot be explained in the graphs and therefore the
demand functions
together with language should be looked as the new tools to do so.
As far as the CPI, there is much more to the concept of price movements once
the demand with
respect to time is introduced. There would never be a problem of inflation
without time
constraints for necessities. People could simply fight inflation just by
waiting for all prices to
come down to a desirable level and buy when the price is right. Necessities
don't allow that.
Because of today's highly developed and technological world, drawing the line
on necessities is
the most challenging task. However, it can be done and it must be done. Once
it's done
correctly, the Consumer Price Index for necessities only, can be the most
reliable source of data
for quoting the inflation rate.
Is there anything else which hasn't been mentioned yet but seems to be
important? The answer is
the actual inflation rate for necessities. But why such an important matter
was omitted? There
are two reasons for it. The current methodology of collecting information does
not draw the line
on necessities. In some cases it can be controversial what necessities are and
only a mutual
agreement of the public at large can identify the desire to measure or not to
measure certain
goods. But in order to do that, very different surveys and questionaries have
to be issued to
consumers. This is rather a minor reason why the actual inflation rate hasn't
been quoted. The
major reason is that it is not important what the actual necessities'
inflation rate is, but what it is
going to be. Inflation was always understood as the overall upward price
movements for all the
goods and services produced in the economy. But if the new definition of
inflation can be
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CA 02285165 1999-10-07
restricted to necessities, how differently can this affect the notion of the
problem of inflation?
Monetary policies of the central banks directly deal with the problems of
inflation. As far as the
current understanding of inflation, these policies are successful in Canada
and United States in
particular. Because problems of inflation are problems at the national levels,
an actual inflation
for necessities will only maintain current or launch a new policy to deal with
inflation. That's
why the future's inflation rate at continuous basis is the best test for any
policy. How quickly
can any policy be implemented and when it will become effective is another
question.
Is it possible to have zero inflation for necessities once and for all?z6
Because the significance of necessities was emphasized throughout this
project, references to
goods, not services had been made. Unlike services which require mostly human
resources,
production of goods requires human and capital resources. With the exception
of water, fresh air
and sun, most necessities must be produced using available capital resources.
To even consider
zero inflation for necessities, one very important condition must be met. The
economic concept
of scarcity must never apply to necessities. If this condition is not met then
somebody might
be inclined to say that the cave man and cave woman were better offthan a
modern human since
they had enough of everything they needed to live. In different terms this
condition can also be
read as comfortable abundance of human and capital resources to produce
necessities on time
and on continuous basis. As probably noticed, this condition addresses only
the quantity aspect
but not the cost aspect of necessities and at the same, alters the definition
of the concept of
scarcity. Because economic goods are those which are scarce, they cannot be
provided free. But
is it appropriate to say that not free means scarce? There is no doubt that
lobsters, oysters and
caviar are scarce goods because no matter what people might be willing to pay
for them, there
will not be enough for everybody if nature, not people produce them. The real
issue therefore
focuses on capabilities of productive resources to satisfy everyone's needs at
the willingness to
incur the cost since cost becomes a subjective matter. The biggest problem of
scarcities in
necessities lies in resources. The best example of it is mining. Recent
attempts to utilize the solar
energy is the right way to go since solar energy is a renewable source of
energy. What all of this
a6 Monetary policies are designed to deal with inflation. This section
examines whether or not it is possible
to prevent inflation.
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means in terms of scarcities in necessities is a going concern about
capabilities to sustain
long-run production of necessities based on available resources. Once humans
become confident
of having significant control over long-run supply of necessities, then they
may expect only
modest price movements of the productive resources or not expect any price
movements at all.
However, it also requires human resources to produce goods. Scarcities don't
really apply to
human resources in a traditional economy. Unlike the rocket science where
knowledge and
expertise might be hard to find, shortages of labour in a traditional economy
can be quickly
overcome by learning on a job and apprentice programs. These shortages can
also be forecasted
and appropriate actions taken a head of time. Therefore, the issue of rising
prices for necessities
as a result of rising wages cannot have roots in shortages of labour. There
are other reasons for
it. The most common one is a bargaining for higher wages. Such bargaining
whether collective
or individual, explicit or implied (quitting the job because of low salary),
has very psychological
and economic roots. It can be called an opportunity cost for the value of
work. It means that
higher wages for the same job paid in different company attract negotiations.
But it also means
that certain well-paid professions attract a workforce. More well-paid jobs
are created for
example in the technology sector, keeping young individuals on the farms
becomes harder unless
they can earn more. This rising opportunity cost is a problem and is perhaps
the best explanation
of wage hikes. So, here is another condition for no inflation; an opportunity
cost for the value
of work must never go up. It seems that the problem of inflation may persist
because in today's
world the technology sector is booming and the foreseeable future for this
industry is bright.
This is right in one sense and technology's jobs are indeed well paid.
However, it doesn't
necessarily mean that the technology sector drives the opportunity cost. An
opportunity cost
addresses everything. By everything it means: hard work in elementary and
secondary schools to
obtain good grades, undergraduate and graduate education including students'
loans, postponing
marriages and other private affairs to obtain education first, downsizing,
restructuring and other
corporate affairs, reacquiring new skills on continuous basis to keep up with
progress and
technological innovations, disappearance of nine to five jobs, disappearance
of job security and,
at the very end comes demand. Demand for non necessities goods at the consumer
level is
CA 02285165 1999-10-07
unstable which also causes a loss in job securities. But what is the real
reason for such unstable
demand? The reason lies in absolute time constraints for consumption. By
absolute time
constraints it means that nobody can extend 24-hour life cycles of humans. On
average, it takes
eight hours to sleep, another eight hours or even more to work, some extra
time for meals, daily
hygiene, transportation and after all, there is not much time left for
anything else. Even though,
sometimes consumption cannot be precisely defined with respect to time (a good
example of it is
a satisfaction derived from paintings and other decorative products), the
issue of time
constraints remains in all cases where the time to consume a product can be
defined. In terms of
unstable demand it means that consumers have many alternatives but not enough
time to
consume everything they would like, even when their budgets allow to do so.
This leads to
making choices and demanding higher quality, better products all the time. In
economics the
focus had always been on budget constraints but not much if hardly at all on
time constraints.
The budget constraints can be overcome by borrowing money. Nobody however can
borrow
time in a real sense of the meaning. The exception to it is the fact that
people live longer because
they succeed in taking care of themselves but the 24-hour absolute time
constraints are there and
it's impossible to do anything about it.
All of it relates to opportunity cost for the value of work in a very direct
manner. Taking
everything into consideration, it is not clear to what extend such opportunity
cost may have an
impact on upward price movements in a near future. Even if the economy can
keep producing
more using recent technology and innovations, the consumption is often limited
by absolute time
constraints. Isn't the 1999 overall inflation rate some reflection of that?
The answer to the original question of zero inflation for necessities once and
for all is yes.
However "yes" only implies that it's possible. It means that unlike
traditional method of fighting
existing inflation, it is possible to take a pro-active approach to prevent
price movements for
necessities right from the beginning. The pro-active approach seems achievable
when dealing
with capital resources but it might not be so easy when dealing with people.
The psychology of
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CA 02285165 1999-10-07
human behaviour is immeasurable and only absolute time constraints for
consumption can keep
opportunity cost of work stable.
Time constraints impose strict limitations on opportunities.
The specific weights and examples set forth above are provided to illustrate
the invention and
are not intended as limiting. Additional methods within the scope of the
claims will be apparent
to those skilled in the art.
37
