Price Dispersion and Functional Price Indices
Michael R. Baye
Recently, several Konüs cost-of-living indexes that allow stochastic prices have been described. However, under some conditions these indexes may violate an identity axiom and allow utility to increase with the measured cost of living. As an alternative I use literature on consumer surplus to describe a new Konüs index that does not violate the identity axiom and ranks price regimes in the opposite order as indirect utility functions. In addition, it provides a natural way to introduce risk aversion into cost-of-living indexes. This is demonstrated by examining the implication of
risk aversion on the cost-of-living from fixed sample size searches.
Michael R. Baye. “Price Dispersion and Functional Price Indices,” Econometrica, Vol. 53 (January 1985), pp. 217-223.