markets.5 The effective decrease from the virtual to the introductory price of a new good is not captured in the CPI, even in instances when new goods are brought into the market basket very rapidly. The introduction of a new good, and its later diffusion to its ultimate customer base as more consumers learn about it, may be thought of as a series of price reductions. A demand curve that traces the “virtual” prices that some consumers would have been willing to pay for the good can, in theory, be econometrically estimated.6

If significant numbers of new goods are continually invented and successfully marketed, an upward bias will be imparted to the overall price index, relative to an unqualified COLI (though this effect may be partially offset by a downward bias created by the disappearance of goods). There is a component of this bias that can occur even if new goods are linked into the index quickly and expenditure weights are updated frequently. A priori, one might expect that only new goods that provide radically improved capabilities or that are sold at reduced prices relative to predecessors would capture market share quickly enough to generate significant point-of-introduction bias. After all, if the new good offers only minor new capabilities relative to existing goods, the virtual price driving

5  

The relationship between price and market sales is not only a matter of different consumers being willing to pay different prices; it also involves, for many goods, the quantity of the good that any one consumer might purchase, depending on the price—e.g., the initial introduction of varieties of fresh vegetables during the winter, made possible by improvements in the speed and efficiency of transportation networks, is an example. Also, consumers will not all learn about a new product at the same moment in time, which means that the virtual prices should be constructed not only for the period just prior to the introduction of the new commodity into the local marketplace but also for subsequent periods, as more consumers learn about the new product.

6  

The conceptual basis for estimating how virtual demand for new commodities could be introduced into a price index is attributable to Hicks (1940). The idea requires first assuming that a single consumer’s preferences over new and old goods available to the consumer in period t + 1 also apply in period t and earlier. This allows one to look for the lowest price for the new commodity in period t that would cause the consumer to demand zero units in period t: this is the virtual (or shadow) price. With this new price and quantity information for period t, one can proceed to construct a new fixed-weight index.

The new Laspeyres index with period t as the base turns out to equal the initial fixed-base Laspeyres index that ignored the existence of the new commodity, since the new commodity has a zero weight in that period. A Laspeyres index with period t + 1 as the base period, however, would show a period t + 1 gain from the introduction of the new commodity, since the relevant shadow price for the new commodity must be used in periods t and earlier, and the new product has a positive weight in period t + 1. This qualification is critical. Thus, every new product that enters the index requires restating all past values of the index.

A new Paasche index would also now be different from the initial Paasche index. Under the condition that the new good turns out to be a success, the price ratio for the new good will generally be lower than the price ratio for old goods, so the new commodity can steal market share from the old commodities. Thus a new Paasche index will generally show a lower rate of price increase than the old Paasche index.



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