. "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
accurate (as a quality-adjusted measure of price change) for one segment of the population. It may become less accurate for those who do not use cell phones.
Moreover, even if everyone faced the same cell phone prices and everyone used a cell phone, the fact that different people choose cell phones with different bundles of characteristics means (because the hedonic function h is not generally linear) that they generally face different marginal prices for characteristics. These issues become thorny when specific groups—such as the poor, the elderly, or those living in a certain area—consume “bias-corrected” products at significantly different rates or in significantly different varieties than do others.18 Note, though, that these problems are caused by consumer heterogeneity, not the use of hedonic techniques, though they surely complicate our understanding of what is being done with hedonic methods. The hedonic conceptual framework brings to light several difficult issues that have not been fully worked through either by BLS or by academic researchers. In the next section we compare competing hedonic approaches.
Alternative Hedonic Methods
Two basic hedonic adjustment techniques have been developed. For the most part, BLS has pursued an “indirect” approach, designed essentially to supplement price-linking methods when the quality (defined by observable characteristics) of outgoing and incoming models cannot be matched. The method uses a single estimated reference period hedonic function to adjust price quotes—for replacement items that appear at sample outlets—prior to their integration into normal index calculation. The indirect hedonic method is viewed by BLS as an alternative to deletion or cost-based methods for adjusting prices and to the judgments of commodity analysts for assessing comparability of specifications (as such the merits of hedonic methods should be judged against these alternatives). Academic economists, in contrast, have devoted more attention to “direct” techniques, in which indexes are produced directly from estimated hedonic functions based on data for both base and comparison periods.
BLS uses the term “indirect” in reference to a specific way of using hedonic functions to deal with situations in which one variety of a good tracked in the CPI
As the economy moves toward greater product heterogeneity, this aggregation problem may potentially increase with or without hedonics. Noncomparable item replacement procedures generally attribute price differences (or portions thereof) to quality difference, though many people would not be willing to pay that difference. Independent of the mix of quality adjustment techniques used by BLS, there is a positive correlation between the extent of changes in product characteristics and the magnitude of the aggregation problem. The magnitude of the problem, even without hedonics, is not necessarily an argument for ignoring changes in product characteristics.