Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 8 The Data of Macroeconomics
Chapter 24 of 36 Measuring The Cost of Living
Section 7 of 18
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-1- Substitution bias
-2- Introduction of new goods bias
-3 - Unmeasured quality change bias
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-2- Introduction of new goods bias
When a new good is introduced consumers have more variety of choice which reduces cost of maintaining the same economic well-being level.
Suppose you could choose between a $100 gift certificate at a large store that offered a wide variety of goods or a $100 gift certificate at a small store with same prices but a smaller variety.
Most people would pick the store with greater variety because they can chose the product closer to their exact desire or choose to try a new brand for enjoyment of variety.
In effect the increased set of possible choices makes each dollar more valuable.
This is also true with the overall economy.
As new goods become available consumer choice increases the value of each dollar.
Because the CPI is based on a fixed basket of goods and services it does not show the increase in the dollar value created with introduction of new goods.
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When video cassette recorders (VCRs) were introduced in the late 1970s, consumers became able to watch movies at home.
Though not a perfect substitute for watching a new movie at a theater seeing an older movie in the comfort of home was a new option that increased consumers' variety of buying opportunities.
The introduction of the VCR made people better off.
Conversely, achieving the same economic well-being level required fewer dollars than going to the movie theater.
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A fully accurate cost of living index would have reflected the VCR introduction with a cost of living decrease.
The Bureau of Labor Statistics eventually revised the basket of goods to include VCRs and the CPI included VCR price changes.
However, the cost of living reduction caused by the initial introduction of the VCR never showed in the CPI.
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