Producer Price Index Manual: Theory and Practice ... - METAC

Producer Price Index Manual
current month would be this estimated current
month price divided by its observed price in the
previous month. This also would provide an estimated
overlap price of the old size to the new one
in the current month. In subsequent months, the
monthly price relative would be the ratio of the
current to previous month ratio of the prices of the
new size product.
7.22 This chapter discusses these four approaches
to quality adjustment in some detail
along with the assumptions they imply. Because
the prices of the unavailable products are not
measured by definition, the veracity of some of the
maintained assumptions about their price changes,
had they been available, is difficult to establish.
Nevertheless, the objective of each of the methods
is to produce matched comparisons of the prices of
products: to compare like with like from month to
month. When products are replaced with new ones
of a different quality, then a quality-adjusted price
is required to produce a match. If the adjustment is
inappropriate, there is an error, and, if it is inappropriate
in a systematic direction, there is a bias.
Careful quality adjustment practices are required to
avoid error and bias.
A.2.2 Sampling issues
7.23 Sampling issues comprise four main areas
of concern. First, samples lose relevance. A given
set of matched models or products is likely to become
increasingly unrepresentative of the population
of transactions over time. It may be that the
prices of old products being dropped are relatively
low and the prices of new ones relatively high, and
their prices are different even after quality adjustment
(Silver and Heravi, 2002). For strategic reasons,
firms may wish to dump old models, among
other reasons to make way for the introduction of
new models priced relatively high. Ignoring such
unmatched models in PPI measurement will bias
the index downward (see Section G.2.3 in this
chapter). Ironically, the matched models method
compilers employ to ensure constant quality may
itself lead to bias, especially if used with an infrequently
updated product sample. (See also
Koskimäki and Vartia, 2001, for an example.)
7.24 Second, because of the additional resources
required to make quality adjustments to
prices, it may be in the interests of the respondents,
and indeed fall within their guidelines, to avoid
making noncomparable replacements and quality
adjustments. They keep with their products until
they are no longer produced—that is, continue to
monitor old products with limited sales. Such
products may exhibit unusual price changes as
they near the end of their life cycle. These unusual
price changes arise because marketing strategies
typically identify gains to be made from different
pricing strategies at different times in the life cycle
of products, particularly at the introduction and
end of the cycle (Parker, 1992). Yet their weight in
the index, which is based on their sales share when
they were sampled, would remain constant in the
index and probably would be too high at the end of
the life cycle. Further, new and, therefore, unmatched
products with possibly large sales would
be ignored. Undue weight would be given to the
unusual price changes of matched products at the
end of their life cycle. This issue again is resolved
by more frequent sample reselection, though not
necessarily of the sample of establishments but of
products within a given sample of establishments.
7.25 Third, the methodology for selecting replacement
products advises compilers to choose a
comparable replacement to avoid the need for explicit
quality adjustments to prices. Obsolete products
are by their nature at the end of their cycle and
replacements, to be comparable, must also be near
or at the end of their cycles. Obsolete products
with unusual price changes at the end of their cycle
are replaced by other obsolete products with unusual
price changes. This compounds the problem
of unrepresentative samples and continues to bias
the index against technically superior products delivering
cheaper service flows.
7.26 Finally, the sampling problem with the
matching procedure occurs when the respondent
continues to report prices of products until replacements
are forced, that is, until the products
are no longer available, but has instructions to replace
them with popular products. This improves
the coverage and representativity of the sample.
But the wide disparity between the characteristics
of the old, obsolete products and new, popular
ones makes accurate quality adjustment more difficult.
The (quality-adjusted) price changes of very
old and very new products may not be similar as
required by the imputation methods under approach
1. The differences in quality likely are beyond
what can be attributed to price differences in
some overlap period under approach 3, since one
product is in the last stages of its life cycle and the
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