. "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
application of hedonic models, in their current state of development, to additional index categories for use in the CPI. Yet the panel is not convinced that anyone could have done this work any better—or is better equipped to continue work in this area—than BLS.
Hedonics Use and the CPI
To make clear the implications that the shift from implicit quality adjustment to hedonics may have on the CPI, we must first describe the BLS in-store item replacement procedure.30 When a routinely priced item becomes permanently unavailable, BLS field agents are instructed to choose the most similar alternative available at the outlet on the basis of a hierarchical list of characteristics specifications. As explained above, the pure price change for a replacement item in the month of its introduction in the index is measured as the average price change that month among similar items (selected according to one of several different methods). Any remaining difference between the price of the replacement item and the old one is assumed to reflect quality change. The practice of choosing the “most similar” item as the replacement means that the potential quality difference between outgoing and incoming items is smaller than if the practice were to select the most advanced, the newest, or the most frequently purchased product within the same class. Also, this practice increases the number of substitutions that are deemed comparable and that do not require quality adjustment and reduces the magnitude of noncomparability for items that are price adjusted. In 1997, 58 percent of the almost 29,000 nonrent substitutions were judged comparable by commodity analysts (U.S. General Accounting Office, 1999:13). For the subset of substitute items that are deemed noncomparable, BLS then attempts a direct quality adjustment, using hedonics or cost-based calculations or a traditional indirect adjustment method.
Other than in its application to personal computers, hedonic adjustments are producing little if any effect on the CPI.31 The effect of increased use of hedonics is limited by:
its narrow application to noncomparable substitute price quotes,
the nature of CPI item substitution itself, and
U.S. General Accounting Office (1999) provides a detailed explanation of the rules that guide item replacement by BLS commodity analysts. The report also describes how the class-mean and other link methods of adjustment work.
It should be noted that, even with hedonic adjustment, the rate of price decline for personal computers in the CPI or PPI is generally much smaller than that estimated by outside researchers. The research in this area is quite controversial.