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Valuation of New Goods Under Perfect and Imperfect Competition

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  • Hausman, J.A.

Abstract

The Consumer Price Index (CPI) attempts to answer the question of how much more (or less) income does a consumer require to be as well off in period 1 as in period 0 given changes in prices, changes in the quality of goods, and the introduction of new goods (or the disappearance of existing goods). In this paper I explain the theory of cost-of-living indices and demonstrate how new goods should be included using the classical theory of Hicks and Rothbarth. The correct price to use for the good in the pre-intro- duction period is a `virtual' price which sets demand to zero. Estimation of this virtual price requires estimation of a demand function which in turn provides the expenditure function which allows exact calucation of the cost of living index. The data requirements and need to specify and estimate a demand function for a new brand among many existing brands requires extensive data and some new econometric methods which may have proven obstacles to the inclusion of new goods in the CPI up to this point. As an example I use the introduction of a new cereal brand by General Mills in 1989-Apple Cinnamon Cheerios. I find the virtual price is about 2 times the actual price of Apple Cinnamon Cheerios and that increase in consumer surplus is substantial. Based on some simplifying approximations, I find that CPI may be overstated for cereal by about 25% because of its neglect of the effect of new brands. When I take imperfect competition into account I find that the increase in consumer welfare is only 85% as high with perfect competition so CPI for cereal would still be 20% too high

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Bibliographic Info

Paper provided by Massachusetts Institute of Technology (MIT), Department of Economics in its series Working papers with number 94-21.

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Length: 32 pages
Date of creation: 1994
Date of revision:
Handle: RePEc:mit:worpap:94-21

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Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), DEPARTMENT OF ECONOMICS, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA
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Keywords: competition;

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References

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  1. Neary, J. P. & Roberts, K. W. S., 1980. "The theory of household behaviour under rationing," European Economic Review, Elsevier, vol. 13(1), pages 25-42, January.
  2. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
  3. Hausman, Jerry A & Taylor, William E, 1981. "Panel Data and Unobservable Individual Effects," Econometrica, Econometric Society, vol. 49(6), pages 1377-98, November.
  4. Hausman, Jerry A., 1980. "The effect of wages, taxes, and fixed costs on women's labor force participation," Journal of Public Economics, Elsevier, vol. 14(2), pages 161-194, October.
  5. Breusch, Trevor S & Mizon, Grayham E & Schmidt, Peter, 1989. "Efficient Estimation Using Panel Data," Econometrica, Econometric Society, vol. 57(3), pages 695-700, May.
  6. Hausman, Jerry A, 1981. "Exact Consumer's Surplus and Deadweight Loss," American Economic Review, American Economic Association, vol. 71(4), pages 662-76, September.
  7. Deaton,Angus & Muellbauer,John, 1980. "Economics and Consumer Behavior," Cambridge Books, Cambridge University Press, number 9780521296762, April.
  8. Feenstra, Robert C, 1994. "New Product Varieties and the Measurement of International Prices," American Economic Review, American Economic Association, vol. 84(1), pages 157-77, March.
  9. J. A. Hausman, 1976. "Specification Tests in Econometrics," Working papers 185, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. G. Burtless & J. A. Hausman, 1977. "The Effect of Taxation on Labor Supply: Evaluating the Gary Negative Income Tax Experiment," Working papers 211, Massachusetts Institute of Technology (MIT), Department of Economics.
  11. Jerry HAUSMAN & Gregory LEONARD & J. Douglas ZONA, 1994. "Competitive Analysis with Differentiated Products," Annales d'Economie et de Statistique, ENSAE, issue 34, pages 159-180.
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  1. The welfare effect of Apple-Cinnamon Cheerios
    by datacharmer in bluematter on 2007-09-25 00:05:00
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