A new product can be thought of as an extreme improvement in quality—from something that did not exist to something that does. However, the basket of goods that was fixed in the past obviously does not include new goods created since then. The basket of goods and services used in the Consumer Price Index CPI is revised and updated over time, and so new products are gradually included.
But the process takes some time. For example, room air conditioners were widely sold in the early s, but were not introduced into the basket of goods behind the Consumer Price Index until The VCR and personal computer were available in the late s and widely sold by the early s, but did not enter the CPI basket of goods until By , there were more than 40 million cellular phone subscribers in the United States—but cell phones were not yet part of the CPI basket of goods.
The parade of inventions has continued, with the CPI inevitably lagging a few years behind. The arrival of new goods creates problems with respect to the accuracy of measuring inflation. The reason people buy new goods, presumably, is that the new goods offer better value for money than existing goods.
Thus, if the price index leaves out new goods, it overlooks one of the ways in which the cost of living is improving. In addition, the price of a new good is often higher when it is first introduced and then declines over time. If the new good is not included in the CPI for some years, until its price is already lower, the CPI may miss counting this price decline altogether.
By the early s, the Bureau of Labor Statistics was using alternative mathematical methods for calculating the Consumer Price Index, more complicated than just adding up the cost of a fixed basket of goods, to allow for some substitution between goods. It was also updating the basket of goods behind the CPI more frequently, so that new and improved goods will be included more rapidly. For certain products, the BLS was carrying out studies to try to measure the quality improvement.
For example, with computers, an economic study can try to adjust for changes in speed, memory, screen size, and other characteristics of the product, and then calculate the change in price after these product changes are taken into account. But these adjustments are inevitably imperfect, and exactly how to make these adjustments is often a source of controversy among professional economists.
Over one or a few years, this is not much; over a period of a decade or two, even half of a percent per year compounds to a more significant amount. These cookies ensure basic functionalities and security features of the website, anonymously. The cookie is used to store the user consent for the cookies in the category "Analytics". The cookies is used to store the user consent for the cookies in the category "Necessary".
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This framework means that the inflation rate indicated by the CPI reflects the changes in the cost of living or the cost of maintaining a fixed standard of living or quality of life.
In other words, it is a cost-of-living index. To illustrate a simplified example of the effect of the CPI on consumer behavior and its different calculation methodologies, assume the following scenario where substitution happens at the item level within a category in keeping with the BLS methodology.
Suppose that the only consumer good is beef. There are only two different cuts available - filet mignon FM and t-bone steak TS. A set of prices have been constructed to reflect this scenario and are presented in the table below. The CPI, or inflation, for this contrived scenario, is calculated as the increase in the cost of a constant quantity and quality of beef, or a fixed basket of goods.
This method is unaffected by whether consumers change their buying habits in response to a price increase. This result is identical to that obtained with the fixed basket method used by Williams. The previous calculations showed that the CPI methodology used by the BLS, given the scenario and consumer behaviors described above, result in a CPI that depends on consumer behavior. Furthermore, an inflation level that is lower than an observed price increase can be measured.
Although this example is contrived, similar effects in the real world are definitely within the realm of possibility. Investors could use the official CPI numbers, accepting the government reported figures at face value.
Alternatively, investors are faced with choosing either Williams' or Ranson's measure of inflation, implicitly accepting the argument that the officially reported figures are unreliable. Therefore, it is up to investors to become informed on the topic and take their own stance on the issue. Different CPI levels for a single price increase, depending upon consumer behavior, can be calculated using the BLS methodology, and it is not implausible that, depending upon consumption patterns, different rates of inflation may be experienced by a consumer.
Therefore, the answer may be investor-specific. Government Accountability Office. John Williams' Shadow Government Statistics. Library of Economics and Liberty. Accessed May 6, Social Security Administration. Lifestyle Advice. Actively scan device characteristics for identification. Use precise geolocation data. Select personalised content. Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads.
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