Adjusting VCR Prices for Quality Change: A Study Using Hedonic Methods

Article excerpt

Rapidly changing consumer electronic goods present particular difficulties when compiling a constant quality CPI; hedonic methods are used to quality-adjust price change for video cassette recorders

Are there any "low hanging fruit" (or benefits) to be harvested from the use of hedonic methods to quality-adjust video cassette recorder (VCR) prices?(1) According to the December 1996 Final Report of the Advisory Commission to Study the Consumer Price Index (CPI), an upward bias of 0.6 percent per year in the CPI is attributable to unmeasured quality change and new goods.(2) To estimate the biases attributed to quality change and new products, the advisory commission divided the CPI'S market basket (the set of all consumer goods and services) into 27 major categories. The category that contributed the most to the quality change bias estimate was the Appliances Including Consumer Electronics component. The Bureau of Labor Statistics responded to the advisory commission's bias estimate acknowledging "... that [high-tech consumer goods] present particularly difficult measurement problems, but the quantitative evidence is very fragmentary and the BLS is reluctant to speculate as to what the magnitude of any bias component might be."(3)

In this study, the hedonic technique is used to estimate (implicit price) values for video cassette recorder (VCR) characteristics, and these estimates are used to quality-adjust VCR price changes when a new VCR model replaces an older model in the CPI sample. These adjusted VCR price changes are used to calculate a quality-adjusted price index. The resulting quality-adjusted index is, ideally, free of quality change bias. We compared it with the published CPI index to obtain an estimate of the quality change bias for VCRs.

Market basket includes VCRs

The inclusion of VCRs in the CPI came almost a decade after their introduction to the marketplace. As pan of the major CPI revision that went into effect in January 1987, BLS included VCRs in the CPI market basket and they became pan of the Video Products Other Than Televisions item stratum (the lowest level of item aggregation for which the CPI calculates indexes).(4)

Many critics of the CPI contend that BLS introduces new products too late and tracks outdated products too long.(5) The advisory commission describes the "new product" bias as follows:

    A pervasive phenomenon called the "product cycle" is critical in assessing
    the issue of new product bias in the CPI and applies as well to new models
    of existing products. A typical new product is introduced at a relatively
    high price with sales at a low volume. Soon improvements in manufacturing
    techniques and increasing sales allow prices to be reduced and quality to
    be improved. For instance, the VCR was introduced in the late 1970s at a
    price of $1,000 with clumsy electromechanical controls; by the mid 1980s
    the price had fallen to $200 and controls were electronic, with extensive
    preprogramming capabilities. Later on in the product cycle, the product
    will mature and eventually will increase in price more rapidly than the
    average product of its class. The sequence is easily visualized as a
    "U"-shaped curve--the price of any given product relative to the consumer
    market basket starts high, then goes down, is flat for a while, and then
    goes back up. To the extent that the CPI overweights mature products and
    underweights new products, it will tend to have an upward bias.(6)

In response, BLS proposed to implement a more aggressive product initiation program, which would identify and include in the CPI new goods promptly after they enter the marketplace.(7) Estimating the magnitude of the new product bias on the CPI due to the late inclusion of VCRs exceeds the scope of this article.(8) However, acknowledging this "new product" bias, especially in the context of the "product cycle" helps to distinguish this type of bias from the "quality change" bias that is the subject of this article. …