Sources of Bias and Solutions to Bias in the CPI

39 Pages Posted: 25 Oct 2002 Last revised: 29 Nov 2022

See all articles by Jerry A. Hausman

Jerry A. Hausman

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: October 2002

Abstract

Four sources of bias in the Consumer Prices Index (CPI) have been identified. The most discussed is substitution bias, which creates a second order bias in the CPI. Three other changes besides prices changes create first order effects on a correctly measured cost of living index (COLI). (1) Introduction of new goods creates a first order effect of new good bias' (2) Quality changes in existing goods will lead to quality' bias, which has first order effects (3) Shifts in shopping patterns to lower priced stores can create first order outlet bias'. I explain in this paper that a pure price' based approach of surveying prices to estimate a COLI cannot succeed in solving the 3 problems of first order bias. Neither the BLS nor the recent report C. Schultze and C. Mackie, eds., At What Price (AWP, 2002), recognizes that to solve these problems, which have been long known, both quantity and price data are necessary. I discuss economic and econometric approaches to measuring the first order bias effects as well as the availability of scanner data that would permit implementation of the techniques. Lastly, I review recent research that demonstrates that these sources of bias are large in relation to measured inflation in the CPI.

Suggested Citation

Hausman, Jerry A., Sources of Bias and Solutions to Bias in the CPI (October 2002). NBER Working Paper No. w9298, Available at SSRN: https://ssrn.com/abstract=344882

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