Do inequality and prices affect comparisons in living standards? The Indian evidence

Notwithstanding the wide recognition that movements in relative prices and inequality affect welfare comparisons between households, there is a dearth of literature incorporating them in welfare analysis. Changes in relative prices open up a divergence between nominal and real expenditure inequalities that will persist even if all nominal expenditures are deflated by a household invariant price index. In a period of rising inequality, a comparison of summary welfare measures based on mean or median expenditure, even if inflation adjusted, will give us a misleading picture of changes in living standards. This paper provides evidence for India in the post-reform period. The results confirm that in a period of significant relative price changes and rising inequality, the omission of these factors leads to overstatement of the welfare gains. Another observation is that relatively affluent states do not do all that well if we focus on inequality or on their food consumption alone.