Reply #23: The IF is the big part. [View All]

[pinqy]

IF you're eating 5lbs of sirloin and and switch to 5lbs of hamburger, yes you took a hit. But the model doesn't assume that at all not could that happen.

Under the current geo-means forumla, steak and hamburger are seperate item categories and cannot be substituted anyway.

Under the chained, they can be, though it isn't a direct sub.

Here's how it really goes..Let's say you're eating 3lbs of sirloin at $8.99/lb and 6lbs of flank at $5.99/lb for a total beef bill of $62.91
The price of beef goes up 5%, so sirloin now costs $9.44/lb and flank $6.24/lb. BOTH the LaSpeyres and geo-means indexes would show a total increase of 5% and a new beef bill of $66.06.

But what if sirloin went up 15% more...to $10.86/lb? Assuming no substitution, the LaSpeyres would show a new beef bill of $70.30...a 11.75% increase from the original. The geo-means index would show an increase of 10.01% giving a new beef bill of $69.21
This could be represented by going down in sirloin to 2.5lbs and going up in flank to 6lbs 11oz trading off 8oz of sirloin for 11oz of flank. Is that an unreasonable substitution leading to lower standard of living?

What you seem to be thinking is that the index would show a total substitution to flank, which is simply not the case.

Yes, the geo-means and chained indexes are lower, but that's because LaSpeyres OVERESTIMATES the change.