. "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
replaced by a 1-pound pack, a strictly defined Laspeyres index is an impossibility. However, it is possible to go forward in this framework if the item for pricing has been defined as “butter” instead of “half-pound packets of butter.” In our earlier gasoline example, a Laspeyrian working in this fashion would price “miles from fuel” and not “gasoline.” The Laspeyres approach has no difficulty pricing characteristics, provided of course that one has some way of identifying and measuring the relevant ones, a difficulty that is common to all approaches. Any Laspeyres-type approach must, however, begin with a definition of the goods (which may be characteristics) to be priced. Selection must be based on some clear notion (e.g., market share) that the set of goods represents that which people buy and what gives them utility. This is as true in a world of fixed quality as in one with changing quality. It is important not to confuse the issue of the definition of goods with the issue of a COLI versus a COGI.
The arguments and recommendations in this chapter reflect the panel’s view that the CPI should be adjusted, for most categories of goods and services, to account for changing quality. In the next two sections, we review evidence on quality change bias. First, we briefly examine the Boskin commission report (Boskin et al., 1996) which focused on factors that are external to the CPI sample. We then review CPI methods for adjusting quality-changed items within its sample as well as potential biases associated with those methods, reserving the special case of hedonic adjustment methods for the following section.
EVIDENCE FROM THE BOSKIN COMMISSION REPORT
In accordance with its congressional charge, the Boskin commission ventured to estimate, by source and by item strata, biases in the U.S. CPI, relative to a hypothetical cost-of-living index. The commission’s report (Boskin et al., 1996) estimates quality change and new product bias (which they treat interchangeably) to be 0.612 percentage points per year—the largest component of its overall CPI bias estimate of 1.1 percentage points.5 The commission’s report has received extensive attention in the academic literature; numerous studies (both pre- and post-Boskin) corroborate the general view that quality change bias exists, though there is much debate on the size and sources of the biases. Much of the research has focused on specific index items (e.g., Berndt et al.  on prescription drugs, Cutler et al.  on hospital and physician services, Hausman  on new cereal varieties). Shapiro and Wilcox (1996) did estimate an overall CPI bias, in the range of 0.6 to 1.5 percentage points per year, but it is extrapolated from trends for a limited number of products and not from an evaluation ranging across all CPI item categories. Unfortunately, research on the potential magni-
Though the Boskin commission does not attempt to identify separate quality change and new goods bias estimates, the report does make some descriptive distinctions between the two categories.