market penetration may eventually reduce the relevance of geographic (or demographic group) indexes. In addition, the relevant region of any transaction is becoming more difficult to define. A consumer in Chicago may buy an item produced overseas, sold by a dotcom operating in San Jose, and shipped from a warehouse in Alabama. Theory suggests that elimination of information and geographic market barriers will force retailers toward operating at uniform profit margins. But some unconventional pricing practices within the Internet retailing sector have also emerged: companies that are surviving on market capitalization may operate with large accounting losses, generally in an effort to maximize not short-run profit but market share, though this phenomenon is rapidly perishing with the widespread failure of dotcom start-ups. However, one should not overstate the case for price convergence, given that the evidence so far is surprisingly weak. Part of the reason may be that e-retailers (like catalog merchants) have the ability to price discriminate on the basis of a consumer’s past purchasing behavior or, perhaps, information obtained about the purchaser from other vendors. Furthermore, major CPI components, such as housing and utility services, will always be affected by local market conditions and institutional factors.
The research attempting to estimate the extent of outlet substitution bias is thin.22 Reinsdorf’s 1993 study, probably the most cited on the topic, formally outlines the underlying theory and offers empirical evidence that outlet price differentials are at least partly real rather than merely reflective of quality differences. Reinsdorf—whose research served as the basis for the Boskin commission’s outlet substitution bias estimates—compared food and motor fuel prices from outgoing and incoming samples during a 2-year overlap period when samples were being rotated. New sample prices were on average about 1.25 percent lower. Given that sample rotation occurs every 5 years—and given the rather strong assumption that the lower prices were not accompanied by a deterioration in service or other outlet-related quality elements—this implies a 0.25 percent annual bias in the relevant components of the index. Reinsdorf provided a second estimate by tracking changes of CPI components against unlinked average price-paid data (also published by BLS). For foods the average price indexes rose 2 percent more slowly than did linked CPI subindexes, and for unleaded gasoline 0.9 percent slower. Since quality change is not controlled for, Reinsdorf asserted that these estimates should be thought of as an upper bound of sorts for the outlet substitution bias.
Lebow et al. (1994) adjusted the Reinsdorf estimate to reflect that only a subset of CPI goods are affected by outlet substitution. The authors determined