Why Price Index Number Formulae Differ: Economic Theory And Evidence On Price Dispersion

Acknowledgements are due to the UK Office for National Statistics (ONS) for supplying the data for this study. This follows a well established research link with the ONS which has been of much benefit to the authors. Naturally the ONS are not responsible for any views, errors of omission or commission in this paper. We also acknowledge useful comments from Malcolm Galatin (City College New York). Abstract: The results from different index number formulae can differ and can do so substantially. The main criteria for explaining such differences, and governing choice between them, are their ability to satisfy desirable test propertiesthe axiomatic approachand their correspondence with plausible substitution behavior as predicted from economic theory. Yet the numerical differences between such formulae has been shown to be related to the extent of, and changes in, the dispersion of prices. However, within the index number literature there is, to the authors knowledge, no formal attempt to explain differences between the results from individual formulae in terms of theories and evidence on price dispersion. Explaining differences between formulae in terms of changes in the dispersion of prices benefits from the existence of economic theoretical frameworks to explain such dispersion