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 9 of 18
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An Inflation Debate Brews over Intangibles at the Mall, by Timothy Aeppel
Accounting for Quality Change.
Behind every macroeconomic statistic are thousands of individual data pieces, and a few key judgments.
To most people, when the price of a 27-inch television set remains $329.99 from one month to the next, the price hasn't changed.
But not to Tim LaFleur.
He's a commodity specialist for televisions at the Bureau of Labor Statistics, the government agency that assembles the Consumer Price Index (CPI).
In this case, which landed on his desk last December, he decided the newer set had important improvements, including a better screen.
After running the changes through a complex government computer model, he determined the improvement in the screen was valued at more than $135.
Factoring that in, he concluded the price of the TV had actually fallen 29%.
Mr. LaFleur was applying the principles of hedonics, an arcane statistical technique that's become a flash point in a debate over how the U.S. government measures inflation.
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Hedonics is essentially a way of accounting for the changing quality of products when calculating price movements.
That's vital in the dynamic U.S. economy, marked by rapid technological advances.
Without hedonics, the effect of consumers getting more for their money wouldn't get fully reflected in inflation numbers.
Many critics complain the hedonic method is distorting the picture of what's going on in the economy.
They say hedonics is too subjective and fear it helps keep inflation figures artificially low.
It's critically important for consumers, business, the government and the economy as a whole the CPI is as accurate as possible.
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The CPI is used to benchmark how much is paid to Social Security recipients, who last year received outlays of $487 billion.
It also plays a role in adjusting lease payments, wages in union contracts, food-stamp benefits, alimony and tax brackets.
Inflation watchers at the statistics bureau say critics exaggerate the significance of hedonics, noting it's used in only seven out of 211 product categories in the CPI.
In most of those, officials say, hedonics actually magnifies price increases rather than suppressing them.
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The bureau says hedonics actually helps boost the housing component of the CPI.
To take into account the aging of housing, and presumably falling quality that goes with it, the CPI applies a form of hedonics that links the age of a housing unit to rents.
If someone is paying the equivalent of $500 a month in rent for several years, the rent has actually gone up as the unit ages and becomes less desirable, according to the government.
The hub of this effort is a warren of beige-walled cubicles at the Bureau of Labor Statistics a few blocks from the Capitol.
Here, 40 commodity specialists hunch over reports with 85,000 price quotes that flow in from around the country every month.
The numbers are gathered by 400 part-time data collectors.
They visit stores and note prices on the items that make up the basket of goods in the CPI, ranging from ladies' shoes to skim milk to microwave ovens.
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One of the biggest challenges in this process is finding substitutes for products that disappear from store shelves or change so much they are hard to recognize from one month to the next.
With TVs, for instance, data collectors find the models they priced the previous month missing about 19% of the time over the course of a year.
When that happens, the data gatherer goes through a four-page checklist of features such as screen size and the type of remote control to find the nearest comparable model.
Once this process identifies a product that appears to be the closest match, the data gatherer notes its price.
The commodity specialists back in Washington check over these choices and decide whether to accept them.
Many price adjustments in the CPI are straightforward.
When candy bars get smaller, but are sold for the same price, the CPI reflects that as a price increase.
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Todd Reese, the commodity specialist for autos, says he doesn't need hedonics to extrapolate the value of quality changes, because auto makers present him with a list of changes to the car and the corresponding prices.
Still, Mr. Reese must make some tough calls as he does his job.
For instance, he recently considered a 2005 model in which the sticker price went from $17,890 to $18,490.
The manufacturer cited an extra cost of $230 to make antilock brakes standard, while it said it saved $5 by dropping the cassette portion of the CD player.
The bureau accepted both those items, so the ostensible price increase shrank by $225.
But the car maker also told Mr. Reese it wanted to subtract $30 from the price increase for the cost of putting audio controls on the steering wheel, allowing drivers to change channels without reaching for the radio dial.
"We didn't allow that claim," says Mr. Reese.
"We didn't judge that to be a functional change."
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