. "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
factors that go unrecognized with current CPI methods that bias the index as a representation of changes in the price to consumers of attaining a given level of well-being. A COLI in its purest sense would respond even to changes in non-market goods (such as air quality or commuting time). Moreover, even in a conditional COLI, changes occur in the market—most visibly the appearance of new goods and services—that affect well-being but are not accounted for, at least not immediately, in the CPI.
Estimating the extent of the first source of bias requires evaluating internal CPI quality adjustment practices. BLS uses a range of quality adjustment approaches when a new item replaces an old one in the sample; the result may add all, some, or none of an observed price change to the index. Some of these approaches implicitly adjust for quality differences; others produce direct cost-based or hedonically derived comparisons of quality that are used to adjust observed prices explicitly.
The Boskin commission report emphasized the second sort of quality-related biases, those created beyond the CPI sample and outside of CPI methodology. They focused on one subcomponent: underrepresentation of new market goods in the CPI. One way of thinking about new goods in the context of a price index (due to Hicks, 1940) is to imagine that the good was always available but at such a high price that no one would buy it. When the good is introduced, one can calculate the effect on the cost of living by translating the new availability into a price reduction, from the (imaginary) price that choked off demand to the new (lower) price at which it was first sold. The CPI as calculated makes no attempt to capture this “price reduction” associated with the introduction of new goods (see Hausman, 1997). Nor does it attempt to capture the later similar “effective” price reductions that occur as more and more consumers learn about new goods and experience a reduction in the cost of living because of that knowledge. Since the CPI market basket has historically only been revised every 10 years or so, new goods often entered the basket only after a long delay, and early stages of product price cycles were missed. Other sources of index bias may go undetected, such as those associated with gradual change in the quality of services (medicine, education, airline travel) or intangible aspects of quality change, such as improved stereo sound or television picture quality.
Estimates of the magnitude of quality change bias seem to be closely tied to the type of bias researchers emphasize. Triplett (1997) argues that the Boskin commission arrived at a high-end estimate of quality bias partly because it focused primarily on biases generated by new goods (such as VCRs and mobile phones) during the periods when they were outside the CPI sample. He further suggests that current BLS methods for within-sample adjustment—which occur when an old product disappears from a CPI outlet and is replaced by a new noncomparable one—may impart some downward biases (Triplett, 1997:24): “The implications of the methods used in the CPI for handling quality changes are not well understood by economists; the CPI [Boskin] Commission did not