Quality adjustments cause inflation to be understated

The argument

Inflation indices reduce prices based on improvements in quality, even if these are not reflected in actual price. The reasoning behind the adjustment is that a better product sold at the same money is effectively cheaper, so the index subtracts the estimated value of the improvement. The consequence is that the published figure drifts away from the amount households actually hand over, and it drifts furthest in exactly those categories where products improve fastest. The scale of that drift is easiest to see in electronics. According to the U.S. inflation indices, TV prices have fallen 96% since 1996. While it is true that flat screen TVs are superior technologically to older TVs, the level of adjustment we see from 1996 to 2016 suggests TVs today are 4% the price of a TV in 1996. This is absurd; families that bought $400 TVs in 1996 do not now buy $16 TVs. The same pattern appears in a market where quality changes far more slowly. Likewise, car prices in the U.S. have not risen in almost 20 years based on inflation indices, yet the average price for a car based on the MSRP (Manufacturer's Suggested Retail Price) has steadily climbed for almost all categories of cars. The flaw in the method is an assumption about what a buyer is free to choose. Quality is not a separable item from the good in question that consumers can take or leave: a shopper cannot decline the improvements and buy the 1996 television at the 1996 specification, because the only product on sale is today's product at today's price. Consumers have to pay whatever the good costs today and cannot pay a theoretical price that accounts for improvement. Because the index measures a price no household is able to pay, inflation is understated.

Premises

Counter-arguments

Critics reply that hedonic adjustment is methodologically justified: a $400 TV from 1996 and a vastly superior modern set are not the same good, so refusing to adjust for quality would *overstate* inflation by counting genuine value gains as pure price. The adjustment is meant to compare like with like. They add that the 'no family buys a $16 TV' point conflates the price of a constant-quality unit with what people actually spend — different measures — and that statistical agencies adjust in both directions. Independent price indices, such as the Billion Prices Project, broadly track official CPI, which suggests no large systematic understatement of the kind claimed.

Rejecting the premises

[Rejecting P1] A 1996 TV and a far superior modern TV are not the same good; refusing to adjust for quality would overstate inflation by counting genuine value gains as pure price, so the adjustment is justified. [Rejecting P2] The 'no family buys a $16 TV' point conflates the price of a constant-quality unit with what people actually spend, which are different measures. [Rejecting P3] Agencies adjust in both directions and independent price indices broadly track official CPI, so there is little evidence of the large systematic understatement claimed.