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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
appears for the period t Paasche index. Thus, under the above conditions, a Paasche index will often be considerably lower than its Laspeyres counterpart.10
Typically, at least in high-tech sectors, a new good does come to the market at a relatively high price and initially has a small volume of sales. High prices may reflect both production costs that have yet to be reduced by learning and process innovation and seller attempts to maximize profits by first selling to customers for whom the new product is especially valuable. Subsequently, prices often fall.
Armknecht et al. (1997) describe the price cycle observed after the introduction of VCRs to the market. Early in the product cycle, in 1978, approximately 400,000 units were sold at an average price of more than $1200. By 1987, when VCRs were introduced into the CPI, annual sales had increased to almost 12 million units, and the average price was less than $500. Over this period, prices decreased by 60 percent, non-quality adjusted, and, by the time of introduction to the index, sales accounted for about 0.1 percent of consumer expenditures (Armknecht et al., 1997:388). Dulberger (1993) showed how, for such products, more frequent replenishing of item samples can have a large effect on measured price change. Her analysis of semiconductors produced a chained Fisher index that decreased by 29.2 percent per year when new chips were introduced into the index with only a 1-year delay after appearing on the market. However, the index only decreased by 20.1 percent when there was a 3-year delay, and the index showed virtually no price decrease when the lag was 5 years (Dulberger, 1993:Tables 3.7, 3.8).
Observed price patterns such as these have led to charges, by the Boskin commission and others, that delayed introduction of new goods systematically omits product-cycle dynamics that impart an upward bias on price indexes. More frequent updating of the item classification structure and of the sample (which, in turn, would require more frequent index chaining) would have allowed a greater portion of these early product price trends to be captured and led to a more accurate plutocratic index. Each case, individually, would not have had a large cumulative effect on the overall CPI (for VCRs, well under one-tenth of 1 percent). However, in the modern economy, a large number of new goods are introduced each year, each having some effect. It is important to note, though, that not all goods follow this kind of pricing path during their life cycle. Pakes (1997), for instance, has stressed producer efforts to penetrate markets with low introductory
As discussed in Chapter 2, the Paasche and Laspeyres indexes are both valid measures of price change between periods. If only one measure of overall price change is required, it can be argued that an average of these two indexes, such as the Fisher ideal index, which takes the geometric mean of the two indexes, offers a sensible approach. Under the conditions outlined, the Paasche and Fisher indexes will give a lower measure of price change. Thus, one is again led to a strong argument for the production of a superlative index in addition to the present real-time CPI.