Quality adjustment of price indexes (EXCERPT), Monthly Labor Review Online, Dec. 1993

Quality adjustment of price indexes

Mary F. Kokoski

As an intended measure of pure price change over time, the Consumer Price Index (CPI) should not incorporate as price changes those differences in prices that may reflect differences in the quality attributes of the goods, as perceived by the consumer. If, for example, a microwave oven is replaced by the manufacturer with a new model that has a larger capacity and a higher price, the value to the consumer of the increase in oven capacity should be subtracted from the observed price difference for purposes of the CPI.

Unfortunately, the assessment of quality change often is difficult. This article addresses the problem of quality change in the CPI, with particular emphasis on the empirical technique of hedonic regression as a method of measuring the value of quality differences in goods and services. The hedonic methodology provides quantitative information on the importance of measurable quality differences. Given certain assumptions, it offers statistical estimates of the value of differences in quality among heterogeneous goods and services. Throughout the following discussion, the valuation of a physical difference in product characteristics will be referred to as a "real quality difference."

The sections below briefly discuss methods of quality adjustment in the CPI, present a general theoretical model for the hedonic methodology, and provide empirical results for a sample of food items typically purchased for home consumption. The data relate to the sample of items used in the CPI for the period January through November 1991.

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