EXPLANATORY NOTES


OVERVIEW OF THE ANALYTICAL LIVING COST INDEXES

1 The Analytical Living Cost Indexes are designed to measure the impact of changes in prices on the out-of-pocket living costs experienced by four types of Australian households.

2 Households have been categorised based on principal source of household income, derived from the 2003-04 Household Expenditure Survey (HES). These household groups account for just over 90% of Australian households. The four household types that have been identified as being appropriate for the construction of these indexes, are:

• Employee households (i.e. those households whose principal source of income is from wages and salaries);
• Age pensioner households (i.e. those households whose principal source of income is the age pension or veterans affairs pension);
• Other government transfer recipient households (i.e. those households whose principal source of income is a government pension or benefit other than the age pension or veterans affairs pension) and,
• Self-funded retiree households (i.e. those households whose principal source of income is superannuation or property income and where the HES defined reference person is ‘retired’ (not in the labour force and over 55 years of age).

3 The indexes represent the conceptually preferred measures for assessing the impact of changes in prices on the disposable incomes of households. In other words, these indexes are particularly suited for assessing whether the disposable incomes of households have kept pace with price changes. The Australian Consumer Price Index (CPI), on the other hand, is designed to measure price inflation for the household sector as a whole and, as such, is not the conceptually ideal measure for assessing the impact of price changes on the disposable incomes of households.


MAIN METHODOLOGY DIFFERENCES FROM THE CPI

4 A living cost index is intended to be used to assess changes over time in the purchasing power of the after-tax incomes of households. It is therefore concerned with measuring the impact of changes in prices on the out-of-pocket expenses incurred by households to gain access to consumer goods and services. The item coverage of such an index is determined by reference to the actual money outlays of households on all but investment items.

5 There are a number of ways to construct a consumer price index with at least three widely accepted alternative approaches used by national statistical agencies:

• Acquisitions method: changes in the prices of goods and services acquired (actually received)
• Cost of use method: changes in the prices of goods and services used (consumed)
• Outlays method: changes in the prices of goods or services for which payments were made to gain access to goods and services.

6 From September quarter 1998, the CPI has been designed specifically to measure price inflation for the household sector as a whole. It is therefore constructed using the acquisitions method.

7 These living cost indexes represent the conceptually preferred measures for assessing the impact of changes in prices on the disposable incomes of households. They are particularly suited for assessing whether or not the disposable incomes of households have kept pace with price changes. These indexes are constructed using the outlays approach.

8 In practice, for most goods and services purchased by the reference population, outlays and acquisition occur within a relatively short space of time. There are three areas of expenditure in which these conceptual approaches provide significantly different results:

• purchase of dwellings
• purchase of durable items
• financial services and the use of credit.

9 Under the acquisitions approach in the CPI, the net purchase of housing, the increase in volume of housing due to renovations and extensions and other costs (e.g. maintenance costs and council rates) are included for owner-occupied housing. Changes in rental are measured for that part of the reference population that resides in rented dwellings.

10 Under the outlays approach in these living cost indexes, the changes in the amount of interest paid on mortgages and other costs (e.g. maintenance costs and council rates) are included for owner-occupied housing. Changes in rental are measured for that part of the reference population that resides in rented dwellings.

11 Insurance (other than health insurance) is also treated differently in the living cost indexes. Under the acquisitions approach, the weight for insurance in the CPI relates to the net value of the service provided by the insurance company. In simple terms, the amount of premiums paid by households less the amounts reimbursed by way of claims. Under the outlays approach in these living cost indexes, the weight relates to the gross value of insurance premiums paid by households.

12 Financial services are also treated differently in the living cost indexes. The living cost indexes include mortgage interest and consumer credit charges but exclude all other financial services.

13 Regional weights for the CPI are based on the HES distributions in the capital cities, however the weights in the analytical living cost indexes are based on the HES distributions for the State or Territory. This produces more reliable weights for some of the smaller expenditure categories in these living cost indexes.


METHODOLOGY

14 Construction of the living cost indexes was essentially undertaken in three stages. Stage one was concerned with calculating weights representative of the expenditure patterns of the defined household types. Stage two involved identifying appropriate measures of price change for each of the expenditure weights. The third and final stage was to use the weights to aggregate or average the price change measures.

15 Item weights for the population subgroups were derived mainly from the HES. However, unlike the CPI where estimates are calculated separately for each of the eight capital cities, population subgroup estimates were calculated at the national level only. This was necessary because the subgroup sample sizes at the capital city level were simply too small, for at least some groups, to produce reliable estimates at the capital city level. For this reason it is not possible to produce living cost indexes at the individual city level.

16 The measures of price change, with the exception of those for interest charges, were sourced from the CPI. Price measures for interest charges have been maintained separately by the ABS on a basis comparable with those employed in the CPI prior to September quarter 1998.

17 While most item price indexes were constructed by direct reference to the equivalent CPI expenditure class indexes, some were constructed by reference to lower level CPI price data. The exceptions relate to those items where it is known that different household types face different prices, such as subsidised public transport fares for senior citizens.

18 Over time the ABS will progressively refine the methodology used to construct these indexes to better reflect other differences in prices that may be faced by different household types. An example is making allowances for the possibility that different household types make purchases at different outlet types.


SERIES LINKS

19 These indexes were constructed using three sets of weights. The first set of weights, based on the 1993-94 HES, was used to construct the indexes from June quarter 1998 to June quarter 2000. The second set of weights, based on the 1998-99 HES, was used to construct the indexes from June quarter 2000 to June quarter 2005. The third set of weights, based on the 2003-04 HES, was used to construct the indexes from September quarter 2005 onwards. All indexes are linked at June quarter 2005.


EXPENDITURE PATTERNS OF THE SELECTED HOUSEHOLD TYPES

20 Calculation of the aggregate impact of price changes on each of the household types involves weighting together the price movements recorded for individual goods and services. For each household type, the weight assigned to any particular good or service reflects the proportion of total household expenditure accounted for by expenditure on the item.

21 Table 3 shows average weekly expenditure per household during 2003-04 for each of the four household types, at June quarter 2005 prices. The commodity groups used correspond to the commodity groups used for the current (15th series) CPI.

22 Table 3 illustrates significant differences in expenditures, both in total and at the individual commodity group level across the household types. Although differences in incomes are likely to be a major reason for this, other factors such as the demographic make-up of the households and dwelling tenure would also play a part. For example, Age pensioner households have on average the lowest number of persons per household and Self-funded retiree households have a higher than average rate of outright home ownership.

23 Table 4 presents the same data in percentage terms. It is this data that produces the expenditure shares or weights that are given to each household type, and to which the price movements are applied.

Table 3: Estimated average weekly expenditure in 2003-04, Household type by Commodity group(a)(b)
Commodity group	Employee	Age pensioner	Other government transfer recipient	Self-funded retiree
Average weekly expenditure per household ($)
Food	183	89	105	130
Alcohol and tobacco	89	30	55	59
Clothing and footwear	48	21	27	31
Housing(c)	128	71	106	83
Household contents and services	113	48	58	97
Health	53	31	18	68
Transportation	165	48	60	114
Communication	40	16	25	24
Recreation	142	48	56	130
Education	33	1	10	5
Financial and insurance services(d)	124	20	33	36
Total	1 119	421	553	777
No of Households ('000)	4 463	1 017	1 065	468
Persons/household (no)	2.86	1.57	2.4	1.68
(a) Based on 2003-04 Household Expenditure Survey (HES) at June quarter 2005 prices.
(b) Figures may not add up due to rounding.
(c) House purchases are included in the CPI but excluded from the population subgroup indexes.
(d) Includes interest charges and general insurance. Interest charges are excluded from the CPI and general insurance is calculated on a different basis.

Table 4: Expenditure weights, Household type by Commodity group(a)(b)
Commodity group	Employee	Age pensioner	Other government transfer recipient	Self-funded retiree	CPI
Food	16.38	21.06	18.96	16.78	15.44
Alcohol and tobacco	7.94	7.16	10.01	7.56	6.79
Clothing and footwear	4.33	5.09	4.83	3.99	3.91
Housing(c)	11.45	16.81	19.22	10.64	19.53
Household contents and services	10.12	11.28	10.45	12.55	9.61
Health	4.74	7.32	3.20	8.72	4.70
Transportation	14.70	11.40	10.92	14.67	13.11
Communication	3.60	3.75	4.47	3.03	3.31
Recreation	12.71	11.27	10.15	16.79	11.55
Education	2.94	0.15	1.84	0.64	2.73
Financial and insurance services(d)	11.08	4.71	5.95	4.63	9.31
Total	100.0	100.0	100.0	100.0	100.0
(a) Based on 2003-04 Household Expenditure Survey (HES) at June quarter 2005 prices.
(b) Figures may not add up due to rounding. (c) House purchases are included in the CPI but excluded from the population subgroup indexes. (d) Includes interest charges and general insurance. Interest charges are excluded from the CPI and general insurance is calculated on a different basis.

24 There are some notable differences in the expenditure weights across the household types. For example, the proportion of expenditure allocated to Food is highest for Age pensioner households. It is also relatively high for Other government transfer recipient households. Employee households allocate a higher proportion of their expenditures to Transportation, Education and Financial and insurance services (which includes interest charges) than the other household types. Other government transfer recipients allocate higher proportions of their expenditures to Housing, Alcohol and tobacco and Communication. Self-funded retiree households have higher relative expenditures on Household contents and services and Recreation than the other household types. Health costs account for a significantly higher proportion of expenditure of Age pensioner and Self-funded retiree households.