placements for discontinued items. These replacements, chosen from the same CPI item category, exhibit only incremental quality changes compared to the old products. Goods also appear that are not replacements for any of the items being priced in the current sample but that can be assigned to existing CPI categories. These items may enter the index when retail outlets (and the goods they sell) are rotated in the BLS sample every few years. In addition, though, new goods and services appear that are different enough from existing ones that there is no place for them in any of the CPI categories. Hence, without an explicit decision to add the new item to the list of categories of goods, their impact on general price trends can go unmeasured: VCRs and cell phones are examples of such items that did not enter the index for many years after they appeared on the market.

There are two ways in which the CPI, when used as a measure of changes in living costs, might be biased by the appearance of new goods. First, many of those who advocate a cost-of-living approach to index construction argue that the consumption welfare effects that accompany the appearance of a new good are missed. Under traditional procedures, new goods, both those that enter through item rotation or after item reclassification, are linked into the CPI in such a way that their introduction, in itself, has no effect on the level of the index. But, for example, there were some consumers who found wireless phones so attractive that, rather than do without, they would have paid a higher price than that prevailing when the phones first entered the index (or even at the time of market introduction). An increase in the standard of living of these consumers was made possible by the introduction of the good, but such effects on the cost of living are not captured by simply linking in the new good without making a specific adjustment for the improvement.

The magnitude of the improvement could, in theory, be estimated using detailed market data on the prices of new goods and the quantities sold to infer how much consumers would have paid for the new good rather than doing without. This estimate would then be used to calculate the relative welfare gain associated with the introduction and subsequent consumption of the good. That gain, in turn, would be incorporated into the index as a price decrease. The conceptual and measurement issues at stake here are addressed in Chapter 5. On a measurement basis, is it possible with available econometric tools to estimate the welfare gain with sufficient accuracy and transparency to warrant its use in the way that would be required? Conceptually, even if reliable measurement should become feasible, should the new good welfare effect be treated as if it were just a price decrease and entered into the consumer price index as such? In Chapter 5 the panel examines both the feasibility and advisability, in constructing a COLI, of employing econometric techniques to estimate and incorporate into the index the “virtual” price reduction that accompanies a new good’s appearance in the market.

The second problem posed by the introduction of new goods revolves around the timing of their incorporation into the CPI. New goods are often introduced in

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