Product Innovations, Price Indices and the (Mis)Measurement of Economic Performance

The goal of this paper is to address the problem of 'product innovations' (i.e. new goods. increased variety, and quality change) in the construction of price indices and, by extension, in the measurement of economic performance. The premise is that a great deal of technical progress takes the form of product innovations, but conventional economic statistics fail by and large to reflect them. The approach suggested here consists of two stages: first, the benefits from innovations are estimated with the aid of discrete choice models, and second, those benefits are used to construct 'quality adjusted' price indices. Following a discussion of the merits of such approach vis a vis hedonic price indices, I apply it to the case of CT (Computed Tomography) Scanners. The main finding is that the rate of decline in the real price of CT scanners was a staggering 55% per year (on average) over the first decade of the technology. By contrast, an hedonic-based index captures just a small fraction of the decline, and a simple (unadjusted) price index shows a substantial price increase over the same period. Thus, conventional economic indicators might be missing indeed a great deal of the welfare consequences of technical advance, particularly during the initial stages of the product cycle of new products.