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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
about the advisability of doing so on conceptual grounds (these concerns are discussed in the final section of this chapter).
The practical problem facing statistical agencies is exactly how the virtual price of a new commodity should be estimated. Many aspects of Hausman’s analysis are highly controversial, even in the context of microeconomic research that is not directly tied to policy. Hausman’s findings have been disputed on the grounds that questionable assumptions were built into his econometric specifications, which led to substantial overstatement of the prices that consumers would have paid for the new cereal brand. In a response to Hausman (1997), Bresnahan (1997) argued that Hausman’s model requirements—specifically that there be no demand shocks that cause consumers to shift purchases and that shocks are not reflected in prices because they are unanticipated—are inappropriate. The assumptions required about functional form (the shape of the demand curve) and for system identification simply introduce too much uncertainty to be used as an input into a statistic that must be produced in a replicable fashion on a regular basis. Calculating the price that drives demand for a product to zero requires extrapolation outside the range of price and quantity observations. Hence, it must rely more heavily than conventional demand estimation on untestable assumptions about functional form. Bresnahan (1997:237, 246) concluded that the question of how important new goods are in terms of their contribution to social welfare remains unanswered.8 Procedures for estimating virtual prices would require extensive refinement before they could even be considered for adoption into a national price or cost-of-living index.
Research into welfare and price effects associated with new goods is important and deserves attention, but it is unlikely that such a program will produce a consensus methodology in the near future. Given the level of uncertainty among economists about the accuracy and replicability of current econometric techniques for estimating virtual demand, it would be imprudent for BLS to attempt to adjust the CPI to account for increased welfare that occurs at the point when new products are introduced.9
Conclusion 5-1: Virtual price reductions associated with the introduction of new goods should not be imputed for use in the CPI.
Several members of the panel—particularly those advocating separate price and cost-of-living indexes—are unconvinced that adjusting the CPI to account
It is also worth noting that wealthy consumers are likely to place a higher value on the introduction of (at least some classes of) new goods than poor consumers. Hence, incorporating virtual price reductions into a plutocratic index may have a greater effect than they would if incorporated into a democratic index. An index so adjusted could conceivably become less relevant for low- and middle-income consumers.