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

7. Treatment of Quality Change
1
pˆ t−
n
too must for those comparisons. Option cost
is thus a method for use in stable markets with stable
technologies. Alternatively, it may be preferable
to estimate a one-off adjustment to the preceding
base period price and then compare all subsequent
products with the new option to this estimate;
that is, 10,500/10,300 = 1.019417, or approximately
2 percent.
7.121 In the example above, the prices available
for the options were sales prices. For resource-cost
estimates, the sales prices as estimates of user values
must be adjusted to cost estimates by removing
markups and indirect taxes. Similarly, and more
appropriately in the context of Section B.2, production
costs of options need to be upgraded to
user values by adding price-cost markups and indirect
taxes. Often such data are available only for
one period. If the markups are considered to be in
the same proportion in subsequent periods, then
there is no problem since the retail price changes
would proxy the producer ones after adjustment
for proportionate margins. However, if the average
age or vintage of the products have changed, then
they will be at different stages in their life cycles
and may have different margins.
7.122 Consider the addition of a feature to a
product. Office chairs, for example, can be produced
and sold as standard or with a lever mechanism
for height adjustment. The specification may
always have been the standard model, but this may
no longer be in production. The new spec may be a
model with height adjustment. The cost of the option
is, therefore, known from before, and a continuing
series can be developed by using equation
(7.20) and simply adding the option cost back into
the base period, old price. Even this process may
have its problems. First, the cost (user value) of
producing something as standard, since all new
chairs now have the height adjuster, may be lower
than when it was an option. The option cost
method would thus understate a price increase. It
may be that the manufacturer has an estimate of
the effects of such economies of scale to allow for
further adjustments. Triplett (2002) cites a study
by Levy and others (1999) in which an automobile
theft system was installed as standard but disabled
when the option was not required. It was seemingly
cheaper to produce this way. Second, by including
something as standard, the revenue received
may be less for some sales than the marginal
cost of producing it. The decision to include
it as standard precludes buyers from refusing it. It
may be that they will turn to other manufacturers
who allow them to exclude the option, although it
is unlikely that this will be the sole criterion for the
purchase. The overall effect would be that the estimate
of the option cost, priced for those who
choose it, is likely to be higher than the implicit
revenue purchasers accord it as standard. Third,
the height adjuster may be valued at an additional
amount x when sold separately. There is likely to
be a segment of the market that particularly values
price adjusters and is willing to spend the additional
amount. However, when it is sold as standard
many of the purchasers will not value it so
highly since these were the very ones who chose
the standard chair. The overall user value would be
less than x, although it is not immediately apparent
how much less. Some statistical offices take onehalf
x as the adjustment. Some insight into the proportion
of the market purchasing the standard
products would help generate more precise estimates.
m
m
7.123 Option cost adjustments are similar to the
quantity adjustments, with the exception that the
additional quality feature of the replacement is not
t t 1
limited to size. The comparison is p / ˆ
n
p − m
where
1 1
ˆ t −
p p t −
= + β∆ z for an individual z character-
t t 1
istic where z ( zn
z −
m )
∆ = − . The characteristic
may be the size of random-access memory (RAM)
on a personal computer (PC) as a specific model is
replaced by one that is identical, except for amount
of RAM. If the relationship between price and
RAM is linear, this formulation is appropriate. On
web pages of many computer manufacturers, the
price of additional RAM is independent of other
features, and a linear adjustment is appropriate.
Bear in mind that a linear formulation values the
worth of a fixed additional amount of RAM as the
same irrespective of the machine’s total amount of
RAM.
7.124 The relationship may be nonlinear. For
example, for every additional 1 percent of x, y in-
β= 1.015 , in this case
creases by 1.5 percent ( )
(7.21)
1 1
ˆ t − t −
p
z
m
= pm
β
t t 1
for p / ˆ
n
p − m
as a measure of quality-adjusted price
changes. Again, the z change may reflect the service
flow, but the nonlinearity in the price–z rela-
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