Social Price Indices and Inequality

Abstract

AbstractThis chapter devotes itself to measuring the effect of prices on inequality. It develops new methodologies to compute social price indices. These indices indicate whether the price changes have a favorable (or unfavorable) impact on the welfare of the poor; in other words, whether the price changes have decreased (increased) inequality. Applying this methodology to Thai and South Korean data shows that the price changes have affected the poor more than the rich in both countries. But the impact of prices on inequality had been more pronounced in Thailand. This chapter’s main objective is to measure the effects of changes in relative prices on inequality. The impact of price changes on income inequality can only be calculated if the price index uses a social welfare function defined for many individuals in society. Such an index is called a social cost of living index. It takes into account specific value judgments of the society. This chapter also derives the explicit relationship between social price indices and aggregate inequality measures. This relationship shows that in a society with high inequality, the usual computing method of the inflation rate (based on a single consumer) is likely to give highly biased results.