July 15, 2004

Icelandic CPI

Bjarni Ólafsson posts the components of the Icelandic CPI on his blog, and asks the question, “Is it a sham?” Well, I took a look at them, and have concluded that it is, but not for the reason Willy Sutton thinks. Since it is easy to lose the forest for the trees in such things, (though sometimes you have to look a the trees to see the forest, I don’t have time for that at the moment) I copied out the category headers to get an overall understanding. Here they are:

01 Food and non-alcoholic beverages 15.2
02 Alcoholic beverages, tobacco 4.0
03 Clothing and footwear 5.6
04 Housing, water, electricity, gas and other fuels 22.0
05 Furnishing, household equipment etc. 5.7
06 Health 3.9
07 Transport 14.5
08 Communications 3.1
09 Recreation and culture 13.7
10 Educational services 0.6
11 Hotels, cafés and restaurants 5.4
12 Miscellaneous goods and services 6.5

Before I go on, it is important to know that in order for the CPI to be meaningful, it has to roughly represent the buying habits of the public. As an example, suppose the price of movies suddenly goes up ten times. Has your buying power decreased? That depends on whether you go to movies or not. If so, by how much? By the percentage of your income that you usually spend on movies. You may note that there is a problem here – if the prices of movies go up ten times, you will surely substitute some other form of entertainment for movies, so your buying power will be impacted less than it otherwise would be. However, in the real world prices don’t usually change that fast, and this problem can be addressed by updating the components of the CPI from time to time. (On the other hand, this is a big factor in cross-country comparisons. It is the reason why cost of living in third-world counties is often calculated to be astronomically high – a western bundle of goods is imposed on a country when anyone actually living there would consume a totally different bundle of goods.)

Getting back to our data, the first thing I noticed was category 02. Do Icelanders really spend 4% of their income on alcohol and tobacco? Almost as much as clothing and footwear? More than health? And what about educational services – only 0.6%? Something is wrong. Then I realized, of course, health and education are provided “free” by the government! But they are not really free, someone is paying for them, but can we know how much? Maybe we should include the amount the government spends on these services per capita?

Then I realized that there’s a much better way, an item that really impacts people’s buying power directly – and accounts not only for health and education, but for many other things as well. What should be category lucky-13 of the Icelandic CPI?

UPDATE: Bjarni responds.

Taxes.

But I still think spending 4% of your income on alcohol and tobacco is incredibly high – it would be 21% of the food budget if it were counted as food!

Posted by David Boxenhorn at July 15, 2004 09:58 AM
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"...it would be 21% of the food budget if it were counted as food!"

That is kind of much. Seeing the numbers like that is like waking up after a binge and seeing the heaps of beer cans all over the appartment.

Posted by: Bjarni at July 15, 2004 07:28 PM Permalink

That's a good, and unfortunately, often overlooked element in the equation. In America today, taxes are the single largest budget item of the typical household, and greater than food, shelter, and clothing combined. It's probably far worse in other, higher-taxed, countries.

Posted by: Scott at July 21, 2004 07:08 AM Permalink

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