Quality Adjusted Unit Value Indexes for Consumer IT Goods
This paper demonstrates that Lehr and Lowe price indexes struggle to accurately measure constant-quality price changes during periods of rapid inflation or deflation, revealing substantial discrepancies when compared to alternative quality-adjusted unit value indexes for consumer IT goods.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
To understand how the economy is changing, statisticians must track the price of goods over time. But measuring price is not as simple as comparing a dollar bill today to a dollar bill from ten years ago, because the things we buy are constantly improving. A computer sold today is vastly more powerful than one sold a decade ago, even if the price tag looks the same. To get a true picture of inflation, economists try to separate the cost of the product from the value of its new features. This is known as adjusting for quality. If a phone costs the same but has a better camera, the price has effectively gone down because you are getting more for your money. However, when prices are falling very quickly, as they often do with technology, the mathematical tools used to make these adjustments can sometimes stumble, leading to a distorted view of reality.
A recent study by Ana Aizcorbe, a researcher at the Bureau of Economic Analysis, investigates exactly this problem using data from the consumer technology market. The paper focuses on three specific categories of goods: desktop computers, laptops, and smartphones. These are items where technology advances so rapidly that prices often drop sharply in a short period. The author examined six different methods that economists use to calculate price indexes for these goods. Two of these methods, known as the Lehr and Lowe indexes, are widely used but rely on a specific way of averaging prices that does not account for the general rise in prices across the entire economy, a factor known as inflation. The other four methods used in the study do account for this by converting prices into constant dollars, effectively stripping out the noise of general inflation to see the true change in the cost of the technology itself.
The study reveals a significant gap between the results produced by these two groups of methods. When the author applied the formulas to real sales data for desktops, laptops, and smartphones, the two methods that ignored constant-dollar adjustments told a very different story than the other four. For desktop and laptop computers, the Lehr index, which is one of the methods that does not use constant dollars, appeared almost completely flat, suggesting that prices were not changing at all. In reality, the other four methods showed that prices were falling rapidly. For smartphones, the gap was also substantial. The methods that failed to adjust for constant dollars showed only a slow, weak decline in prices, missing about half of the actual drop in cost that the other methods captured.
The reason for this discrepancy lies in how these indexes interpret the relationship between price and quality. When inflation is high, or when the prices of specific goods are falling very fast, the methods that do not use constant dollars get confused. They mistake the rapid drop in price for a drop in quality. In other words, because the goods are getting cheaper so quickly, these indexes assume the products must be getting worse, rather than recognizing that the technology is simply becoming more efficient and affordable. This leads the index to underestimate how much the price has actually fallen. The study suggests that for sectors like consumer electronics, where prices move quickly, relying on these older methods can lead to a serious underestimation of how much value consumers are actually receiving. The findings indicate that to get an accurate picture of price changes in these fast-moving markets, economists must use methods that properly separate the effects of general inflation from the specific improvements in the products themselves.
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