. "4 Evolving Market Baskets: Adjusting Indexes to Account for Quality Change." At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes. Washington, DC: The National Academies Press, 2002.
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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
Unfortunately, quality adjustment techniques seem destined always to have an ad hoc element. The aspects or characteristics of goods that determine consumers’ perceptions of quality are not consistently observable. Moreover, the quality and taste components of price change are often inexorably intertwined. On the other hand, BLS has to balance on a case-by-case basis the errors that inevitably arise in the adjustment process against the errors that would inevitably arise either from ignoring quality changes or from assuming, as is often done, that all price differences between similar items reflect quality differences. We return to these issues below.
In a conventional Laspeyres index, the changing set of available goods and good characteristics also creates problems. Once an index item from the reference period is replaced by a different item, a strictly defined Laspeyres index cannot be calculated, since an identical bundle can no longer be priced in the comparison period. Given the pace at which new goods are introduced in a modern economy—ranging from those with slightly modified characteristics to those that are entirely new—it would be highly restrictive to monitor price inflation solely from a bundle chosen for stability. A “Big Mac” index may lead to misleading conclusions about general price movements, particularly since stagnant and dynamic sectors of the economy are likely to display systematically different price trends. Nonetheless, in no small part because of the uses to which they are put, it seems desirable to adjust price indexes to account for changing item quality and to reflect the changing mix of goods over time.
In practice, one need not be methodologically boxed in by this narrow textbook view of a Laspeyres index. And the CPI has in fact been modified—since at least 1967 when BLS began adjusting automobile prices—to address quality issues while, at the same time, maintaining its basic COGI structure. A working definition requires only that a set of market goods and services that are valued by consumers be identified for inclusion in the index. Since purchasing patterns and the set of available products have changed, the basket has been allowed to change over time. The organizing principle is the desire to cover the goods on which people spend most of their money and then to make adjustments to account for quality change. A COGI proponent is likely to argue that quality adjustment is necessary because, when the nature of goods change, prices of like items cannot be compared over time since the original bundle of goods no longer exists. A COLI proponent is likely to add that, since improved products generate higher levels of consumer satisfaction, observed prices must be adjusted to isolate changes in the cost of maintaining living standards. These differences would not affect their evaluations of alternative adjustment mechanisms.
Again, the idea of repackaging helps draw some distinctions between a COGI and a COLI in handling quality change. When two half-pounds of butter are