Measuring Quality-Adjusted Inflation Rates for a Heterogeneous Oligopoly

Abstract

Both the theory and practice of using hedonic regressions to quality adjust inflation estimates are implicitly developed for monopolistic competitive markets. We demonstrate conditions required for consistent OLS estimation of hedonic regression for an oligopoly. To reflect firm heterogeneity, we make two recommendations on empirical practice. The first is to use quantity weights in constructing the index rather than the unsatisfactory equal weighting system implicit in the standard pooled regression. Second, to test for instability across product type, as well as over time. Implementing these recommendations results in higher estimates of inflation, similar to official quality-adjusted inflation rate.

JEL Classification: C51, D43, L62