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On both sides of the quality bias in price indexes

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  • Bart Hobijn

Abstract

It is often argued that price indexes do not fully capture the quality improvements of new goods in the market. Because of this shortcoming, price indexes are perceived to overestimate the actual price increases that occur. In this paper, I argue that the quality bias in price indexes is just as likely to be upward as it is to be downward. I show how both the sign and the magnitude of the quality bias in the most commonly applied price index methods are determined by the cross-sectional variation of prices per quality unit across the product models sold in the market. ; I do so by simulating a model of a market that includes monopolistically competing suppliers of the various product models and a representative consumer with CES (constant elasticity of substitution) preferences. I illustrate the bias in the commonly applied price index methods by comparing their estimates of inflation with the theoretical inflation rate implied by the data-generating process.

Suggested Citation

  • Bart Hobijn, 2002. "On both sides of the quality bias in price indexes," Staff Reports 157, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:157
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    References listed on IDEAS

    as
    1. Feenstra, Robert C, 1995. "Exact Hedonic Price Indexes," The Review of Economics and Statistics, MIT Press, vol. 77(4), pages 634-653, November.
    2. repec:ucp:bknber:9780226304557 is not listed on IDEAS
    3. Mark Bils & Peter J. Klenow, 2001. "Quantifying Quality Growth," American Economic Review, American Economic Association, vol. 91(4), pages 1006-1030, September.
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    6. Feenstra, Robert C, 1994. "New Product Varieties and the Measurement of International Prices," American Economic Review, American Economic Association, vol. 84(1), pages 157-177, March.
    7. Ariel Pakes, 2003. "A Reconsideration of Hedonic Price Indexes with an Application to PC's," American Economic Review, American Economic Association, vol. 93(5), pages 1578-1596, December.
    8. Ana M. Aizcorbe, 2002. "Why are semiconductor prices falling so fast? Industry estimates and implications for productivity measurement," Finance and Economics Discussion Series 2002-20, Board of Governors of the Federal Reserve System (U.S.).
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    10. Robert J. Gordon, 1990. "The Measurement of Durable Goods Prices," NBER Books, National Bureau of Economic Research, Inc, number gord90-1, July.
    11. G. Christian Ehemann & Brent R. Moulton, 2001. "Balancing the GDP Account," BEA Papers 0014, Bureau of Economic Analysis.
    12. Diewert, W. E., 1976. "Exact and superlative index numbers," Journal of Econometrics, Elsevier, vol. 4(2), pages 115-145, May.
    13. Mick Silver & Saeed Heravi, 2003. "The Measurement of Quality-Adjusted Price Changes," NBER Chapters,in: Scanner Data and Price Indexes, pages 277-316 National Bureau of Economic Research, Inc.
    14. David E. Lebow & Jeremy B. Rudd, 2001. "Measurement error in the consumer price index: where do we stand?," Finance and Economics Discussion Series 2001-61, Board of Governors of the Federal Reserve System (U.S.).
    15. Lloyd, P J, 1975. "Substitution Effects and Biases in Nontrue Price Indices," American Economic Review, American Economic Association, vol. 65(3), pages 301-313, June.
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    Citations

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    Cited by:

    1. Piazzesi, Monika & Schneider, Martin & Tuzel, Selale, 2007. "Housing, consumption and asset pricing," Journal of Financial Economics, Elsevier, vol. 83(3), pages 531-569, March.
    2. Emi Nakamura & Jón Steinsson, 2012. "Lost in Transit: Product Replacement Bias and Pricing to Market," American Economic Review, American Economic Association, vol. 102(7), pages 3277-3316, December.
    3. Adam Hale Shapiro & Ana Aizcorbe, 2010. "Implications of Consumer Heterogeneity on Price Measures for Technology Goods," BEA Working Papers 0062, Bureau of Economic Analysis.
    4. Karen Dury & Özlem Oomen, 2007. "The real exchange rate and quality improvements," Bank of England working papers 320, Bank of England.

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    Keywords

    Price indexes ; Oligopolies ; Consumer behavior;

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