of BLS item replacement procedures and their associated biases. Chapter 5 considers separately the case when goods appear that do not fall into existing product categories. The second half of this chapter assesses the role of hedonic regression techniques in quality adjustment. We offer specific recommendations about the applicability of hedonics for adjusting observed prices or for directly constructing indexes and about approaches to selecting items for quality adjustment.2

COLI AND COGI VIEWS OF THE QUALITY CHANGE PROBLEM

The general problem of changing quality can be illustrated by simple example. Consider a price index for automobiles for which, in the reference period, the dominant type of automobile has a steel dashboard and no seat belts and is a gas guzzler. Now suppose that, in the comparison period, the dominant type of automobile has leather appointments, airbags, and efficient fuel economy. Direct comparison of the nominal prices of these cars will yield little meaningful information. What does it tell us if the price of a 2002 Camry is 10 times that of a 1965 Rambler? Similarly, if this year’s computer model costs the same as last year’s but does more and does it faster, what does the observed price constancy really tell us? Nordhaus (1998:59-60) points out that a fundamental problem associated with quality change is raised by these types of comparisons because “conventional price indexes measure the prices of commodities that consumers buy rather than the cost of attaining a given level of economic well-being or utility.” The manner in which quality change and new goods problems arise depends to some extent on the index’s underlying conceptual structure whether a cost-of-goods index (COGI) or a cost-of-living index (COLI) though procedures for dealing with these problems are essentially the same in both cases.

COLI

The COLI requires that prices, or the index itself, be adjusted to account for effects on living standards that accompany changes in the quality of goods and services. For certain commodities, the quantitative adjustment could be straight-forward—e.g., the new automobile fuel that increases miles traveled per gallon. But in most cases, the relationship between product or product characteristics (inputs to well-being) and actual well-being created cannot be directly observed.

2  

We bypass the issue of quality change as it affects nonmarket inputs to consumer well-being (things like air quality, traffic congestion, and sense of personal safety) that are not captured in conventional price indexes (see Chapter 2). In addition, while we acknowledge the theoretical validity of the Boskin commission’s observation that changes in the variety of available goods and services affect consumer well-being, we know of no useful way to deal with this issue in index construction.



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