Incorporating the Effect of New and Disappeared Products into the Cost of Living: An Alternative Index Number Formula

Abstract

The current Consumer Price Index (CPI) is a biased estimator of the true cost of living (COL). Incorrect treatment of quality change in existing products and the introduction of new products is known to be a major source of the bias. One of the practical problems that make it hard to properly incorporate the effect of newly introduced or disappeared products into the CPI is that the price of a new product in the pre-introduction period and the price of a disappeared product in the period it disappears are unobservable. The present paper introduces an index number formula which overcomes that problem. The index number formula is exact for the constant-elasticity-of-substitution (CES) preference ordering if the elasticity of substitution is known. Unlike the formula introduced by Feenstra (1994), it separates a change in the COL into three parts, Namely, New, disappeared and existing products.