Price indices and adjustments for quality -
As is well known, government price indices have increasingly become artificially manipulated. One of the so called justifications is to adjust for changes in quality, indicating a reduction in price even if the same prices persist, if the current product is judged to possess higher quality than the previous product.
While the entire concept of price indices is incompatible with the Subjective Theory of Value that underlies Austrian Economics, this note only deals with the question of the appropriateness of quality adjustments per se, allowing for the fact that price indices will be published no matter how misguided they may be.
If I buy a pencil, the price that I am willing to pay for it depends on the my subjective ranking of the urgency of the satisfaction in use that it can provide, relative to all the other possible purchases that could be made.
Assume that this year's pencil has improved in quality over last year's model by dint of a new ability to write under water. If the price of this year's pencil is the same as last year's pencil, should its contribution to a price index be reduced to reflect this increased quality?
To answer this question, a certain background is required.
First, prices are ultimately determined by the subjective valuations of consumers, and reflect the balance between the subjective marginal utility of the product and and the subjective marginal utility of money.
Secondly, it is not the pencil itself that determines the value and price, but rather the subjective importance of the use to which the pencil is applied. In particular, the price and value of a pencil is derived from the importance of its ability to deposit visible graphite traces on paper.
If we use this year's waterproof pencil only to deposit visible graphite traces on dry paper, just as we did with last year's model, it should be clear that no additional value has been received, and therefore, no higher price can be justified and discounted, and no quality adjustment to a price index is appropriate.
On the other hand, assume that the new ability is used to deposit visible graphite traces on underwater surfaces. In this case we have a new use, and a new and different product that provides it. In this case we may well be better off for the same expenditure level, but we have a different product, as judged by the consumer, not a lower priced version of the same one.
While the second case is not necessarily greatly misrepresented by a phantom price decrease, the first case is grossly distorted by an adjustment. Since in reality, most pencil purchasers will merely make the same use of the pencil as in the prior year, and pay the same price, a quality adjustment to the price index is entirely unwarranted.
Regards, Don |
