New goods bias

What Is New Goods Bias?

New goods bias refers to a measurement challenge in economic statistics, particularly in the calculation of price indexes such as the Consumer Price Index (CPI). This bias arises because newly introduced goods and services are not immediately included in the fixed market basket used to track prices. Consequently, the initial, often higher, prices of new products and the subsequent price declines as they become more common are not fully captured, leading to an overstatement of inflation and an underestimation of improvements in the cost of living. The new goods bias suggests that traditional inflation measures may not fully reflect the true purchasing power of money over time, as they miss the consumer benefits and often decreasing prices associated with the adoption of innovative products.

History and Origin

The concept of new goods bias gained significant attention with the 1996 report by the Advisory Commission to Study the Consumer Price Index, often referred to as the Boskin Commission. Appointed by the United States Senate in 1995, the commission was tasked with examining potential biases in the computation of the CPI, which is a crucial economic indicator used to adjust various payments and programs. The Boskin Commission concluded that the CPI overstated inflation, identifying new product bias as one of the key contributors.¹⁵ According to the commission, new products were often not incorporated into the CPI's fixed market basket until much later, missing significant price declines that typically occur in the early stages of a product's lifecycle.¹³, ¹⁴ For example, personal computers were not included until 1987, and cellular phones were not added until 1998, well after their initial introduction and periods of rapid price decreases.¹² This delay meant that the CPI overlooked one of the ways in which the standard of living was improving for consumers.¹⁰, ¹¹ The full report, "Toward A More Accurate Measure Of The Cost Of Living," highlighted this and other biases, urging for improvements in inflation measurement methodologies.

Key Takeaways

• New goods bias causes measured inflation to be higher than the actual change in the cost of living.
• It arises because new products are not immediately included in the fixed basket of goods used for price indexes.
• The bias often misses the initial high prices and subsequent rapid price declines of innovative products.
• This leads to an underestimation of improvements in consumer welfare and purchasing power.
• Government agencies like the Bureau of Labor Statistics continually work to mitigate this bias through methodological adjustments.

Interpreting the New Goods Bias

Interpreting the new goods bias involves understanding its implications for how we perceive changes in the cost of living and overall economic well-being. When a price index, such as the Consumer Price Index, fails to account for the swift integration and declining prices of new goods, it can overstate the true rate of inflation.⁹ This means that while nominal incomes might appear to keep pace with measured inflation, the actual improvement in purchasing power and the standard of living due to access to innovative and eventually more affordable products may be understated. The presence of new goods bias suggests that consumers are getting more value for their money than official statistics might initially indicate.

Hypothetical Example

Consider the introduction of a revolutionary new smart home device. When it first hits the market, it might be priced at $500, accessible only to early adopters. After a year, as manufacturing processes improve, competition increases, and the technology becomes more widespread, the price drops to $300. If the Consumer Price Index basket of goods does not include this device until its price has already fallen to $300, the significant price decrease from $500 to $300 is never captured in the official inflation statistics. This omission creates a new goods bias, as the true cost of living for consumers who adopt this technology has decreased more than the CPI would suggest.

Practical Applications

New goods bias has practical applications primarily in the realm of economic measurement and public policy. Accurate inflation measurement is critical for setting monetary policy, adjusting social security benefits, and understanding economic growth.⁸ The Bureau of Labor Statistics (BLS) and other statistical agencies worldwide are constantly refining their methodologies to account for the rapid introduction and evolution of new products. For instance, the BLS periodically updates the contents and weights of the market basket to better reflect changing consumer spending habits, including the adoption of new technologies.⁶, ⁷ Efforts include more frequent updates to the basket and improved techniques for capturing price changes, though the challenge persists due to the dynamic nature of innovation. The NBER highlights ongoing research into methods like machine learning to construct hedonic adjustments to better capture quality changes and new products.⁵

Limitations and Criticisms

While recognized as a significant factor in inflation measurement, the new goods bias presents persistent limitations for statistical agencies. The fundamental challenge lies in incorporating novel products into the price index promptly enough to capture their full price trajectory, especially the initial, often rapid, price declines.⁴ Critics argue that despite efforts, the CPI may still overstate inflation because it struggles to keep pace with the introduction of genuinely new and transformative goods.², ³ Another limitation is distinguishing between a genuinely "new good" and a significant quality improvement to an existing good, which can blur the lines between new goods bias and quality bias. The complexities of accurately measuring the value and impact of new digital services, for example, which may have no direct monetary cost (e.g., free online content), also pose a challenge to traditional inflation measurement.¹ The difficulty in fully accounting for new goods can lead to a misrepresentation of real GDP growth, as the deflator used to calculate real output may be inaccurately inflated, ultimately understating actual economic expansion.

New Goods Bias vs. Quality Bias

New goods bias and quality bias are two distinct, though often related, challenges in measuring inflation, both contributing to the potential overstatement of the true cost of living. New goods bias specifically refers to the issue of how the introduction of entirely new products affects price indexes. It highlights that the benefits to consumers (and often the subsequent price reductions) of these novel items are not immediately or fully accounted for in a fixed market basket calculation. In contrast, quality bias arises when existing goods improve in quality over time, but these improvements are not adequately reflected in their price. For example, a new smartphone model might be more expensive than its predecessor, but it also offers significantly enhanced features. If the price increase is recorded without adequately adjusting for the improved quality, it contributes to quality bias. While new goods bias deals with the entry of new items, quality bias focuses on the evolution of existing items. Both biases can lead to an overestimation of inflation because they suggest that consumers are either gaining access to better value through new products or receiving more utility from improved existing products, without these benefits being fully subtracted from the measured price changes.

FAQs

Q: Why is new goods bias a concern for inflation measurement?
A: New goods bias is a concern because it can lead to an overstatement of inflation. When new products, especially those with rapidly decreasing prices after their introduction (like electronics), are not quickly incorporated into the basket of goods used for the Consumer Price Index, the measured inflation rate doesn't fully capture the improvements in consumer welfare or the decline in the true cost of living.

Q: How do statistical agencies try to address new goods bias?
A: Statistical agencies, such as the U.S. Bureau of Labor Statistics, continuously work to mitigate new goods bias. They do this by periodically updating the composition of the market basket to include new and emerging products. They also employ techniques like hedonic adjustments, which attempt to account for changes in product quality when calculating price changes, although directly addressing the initial non-inclusion of a truly new good remains a challenge.

Q: Does new goods bias always lead to an overestimation of inflation?
A: Yes, the general consensus is that new goods bias tends to cause an overestimation of inflation. This is because the benefits that consumers derive from new products, often at lower prices than their initial introduction or through the availability of entirely new functionalities, are not fully captured by a fixed price index. This means the true increase in purchasing power is understated.