We develop an approach to measuring the cost of living for CES preferences that treats demand shocks as taste shocks that are equivalent to price shocks. In the presence of relative taste shocks, the Sato-Vartia price index is upward biased because an increase in the relative consumer taste for a variety lowers its taste-adjusted price and raises its expenditure share. By failing to allow for this association, the Sato-Vartia index underweights drops in taste-adjusted prices and overweights increases in taste-adjusted prices, leading to what we call a "taste-shock bias." We show that this bias generalizes to other invertible demand systems. ? 2019 The Author(s).

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1 February 2020

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Quarterly Journal of Economics 135(1) , pp.503-560, 2020

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DOI: 10.1093/qje/qjz031

https://academic.oup.com/qje/article-abstract/135/1/503/5579038?redirectedFrom=fulltext

This Journal article is published under the centre's Urban programme, Trade programme.