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

Producer Price Index Manual
variety produced under the current production
process or the cost of the current variety under the
old process may be conceptually appropriate but
practically impossible. Yet answering the cost
question without assuming that technology is fixed
in the current or previous generation can produce
wildly inaccurate results. Consider the market for
personal computers, where price declines have
been accompanied by rapid quality improvements.
7.61 Holdway (1999) illustrated the problem of
using a FIOPI for computer microprocessors such
as the Intel Pentium III. He considered changes in
the speed of new generations of microprocessors
and used the example of the transition from a 66
megahertz (MHz) chip that cost $230 when it was
discontinued to a 90 MHz chip valued at $247 in
the same month. The additional cost of the 24
MHz at that month’s technology’s resource costs
has to be estimated. Suppose the cost of a single
unit of MHz was estimated at $2.0833; multiplying
this figure by 24 yields $50. So what is the pure
price difference between these two chips To make
the new 90 MHz processor equivalent to the old 66
MHz one, the $50 has to be subtracted from its
price and compared with the price of the old one,
that is,: [(247 – 50) / 230] – 1= –0.143: a 14.3 percent
decrease. This is instead of a nominal price
increase of [(247 / 230) – 1] = 0.074 or 7.4 percent.
7.62 Suppose, however, the establishment reports
the unit cost of the 66 MHz unit at the technology
prevailing when the older, slower unit was
designed rather than the unit cost of a 66 MHz unit
from the newer technology underlying the 90 MHz
chip. In this case, it is very easy to misapply the
resource cost method by not comparing costs
within a given generation of production technology.
The new 90 MHz processors were built using
a better technology. They used 0.50 instead of 0.80
micron technology, allowing more features to be
packed into a smaller section of a silicon wafer,
which improved performance. Also, the technology
used to produce them, including an amortization
factor for plant and capital equipment, lowered
unit costs (see Holdway, 1999, for details).
Suppose an estimate was requested as to how
much more it would cost to produce a 90 MHz
chip versus a 66 MHz one, maintaining that the
cost assessment should assume the 66 MHz wafer
technology. Suppose unit costs for the higher performance
chip were $100 more because the old
technology was less efficient than the new technology,
a common occurrence in high-technology
industries. Applying the resource cost method now
provides an estimate of (247) / (230 + 100) – 1 = –
0.252, a 25.2 percent decrease. The higher unit
cost of the faster chip had to be added back to
make it equivalent to the new chip because the resource
cost method measures quality by cost.
7.63 In the latter cases, the method breaks
down. The unadjusted price increase was 7.4 percent.
With a resource cost adjustment using estimates
based on the new technology, there was a
decline of 14.3 percent. Adjusting the prices base
on estimates using the old technology to produce
the new, higher performing chip results in a decrease
of 25.2 percent. In both cases, the cost declines
represent different levels of technology, and
the resource cost approach can give widely different
answers. In industries such as computers and
electronics, where unit prices are falling and technology
is rapidly changing, resource cost quality
adjustment procedures can be misleading as major
technology shifts occur.
7.64 PPIs cannot hold the price basis constant
over long periods. For example, in the 45 years
since the introduction of the commercial computer,
the price of computing power has decreased to less
than one-half of one-tenth of 1 percent (0.0005) of
what it was at its introduction. It has decreased by
more than two thousandfold (Triplett, 1999).
Nordhaus (1997) found substantial increases in the
price of light over much longer periods. Yet if
these price changes reflected overall changes in
producer prices, absurd estimates of output growth
at constant prices would result. The tastes and expectations
of consumers along with the technology
of the producers change over time, and these
changes will be shown in Chapter 21 to affect the
implicit prices attributed to the quality characteristics
of what is bought and sold.
7.65 Because of the effects of changes in relative
price, technology, and taste, we again would
prefer to use the (observed) overlap price and the
hedonic methods—where feasible—rather than the
resource cost and user-value approaches. Further,
rapid technological and taste changes must also be
met by more frequent sample updates to avoid
rapid loss of sample relevance.
B.2.5 Consistency between supply
and use price statistics: assessing
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