. "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
change in the observed price paid by consumers. This method, frequently applied to new automobile models, rests on the strong assumption that the perceived value of improved features or new equipment is equal to the incremental costs incurred by the manufacturer to add them. If producers tend to exaggerate the cost of quality improvements, so that reported cost contains an element of pure price change, then the method imposes a downward bias on the CPI (Kokoski, 1993:35). In such a case, a cost-based adjustment erroneously attributes a portion of the observed price difference to quality change. Until competition catches up, however, one might expect profits to be made from an innovative product improvement. In such a case, the price increase would be larger than the per-unit cost associated with the innovation. To the extent that the higher price equates with added value to consumers, the cost-based method (assuming accurate reporting by the manufacturer) might, by ignoring the profit component, understate the quality component of the observed price change.
The Boskin commission judged that BLS use of manufacturers’ cost data tends to underadjust for quality change and, in turn, imparts an upward bias to the CPI. The commission estimated quality change bias for new vehicles to be .59 percentage points per year for the period 1983-1996 (Gordon et al., 1997:86). The commission argued specifically that, in the case of automobiles, cost-based adjustment did not include a number of manufacturers’ improvements that increased automobile durability and reduced production defects. However, Triplett argues that the Boskin commission assertions about quality bias for new cars were poorly informed (Triplett, 1997:27):
Bureau of Labor Statistics (1997) listed changes, such as increased use of corrosion-resistant metal, for which cost-based quality adjustments for automotive durability have been made in the CPI. Reduced defects must also have come about from changes made by the car makers. In my experience in the BLS, the auto manufacturers never overlooked quality changes when they submitted costs to the BLS. Rather, manufacturers tried to attribute too much price change to quality improvements. . . . The Commission’s idea that quality adjustments are systematically overlooked by the manufacturers when they make reports to the BLS is inconsistent with my experience with these data and also inconsistent with alternative evidence.
Triplett adds that published hedonic studies of new automobiles have produced indexes that rise more rapidly than does the CPI cost-based adjusted index. Griliches (1971:11) also warned that “basing such adjustments largely on data furnished by manufacturers and on ‘producer costs’ may wind up overestimating ‘quality change,’ accepting as improvements expenditures which consumers may not interpret as such.”
Deletion (and also class-mean, which is a more targeted variant of the deletion method) is used when the replacement and replaced items are judged non-comparable and when neither overlapped prices nor producer cost information is available. Excluding sample rotation, when new independent product samples are