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Quality adjustment: a review of some methods with examples from clothing

Quality adjustment: a review of some methods with examples from clothing. Presented by Marc Prud’Homme Chief of Research on Consumer Prices Prepared for the ILO/UNECE workshop series May 2010. Outline. Introduction Some theory Methods of quality adjustment Quality adjustment techniques

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Quality adjustment: a review of some methods with examples from clothing

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  1. Quality adjustment: a review of some methods with examples from clothing Presented by Marc Prud’Homme Chief of Research on Consumer Prices Prepared for the ILO/UNECE workshop series May 2010

  2. Outline • Introduction • Some theory • Methods of quality adjustment • Quality adjustment techniques • Evaluations • Recommended quality adjustment methods • Clothing • Overview • The Canadian Experience • Hedonic model for clothing • Final thoughts Statistics Canada • Statistique Canada

  3. Introduction • The measurement of price change is complicated by the appearance of new products and the disappearance of old products. • Existing products also change. • Price levels are affected • Price changes are affected • Improper treatment = BIAS • Quality bias occurs when the price change is not accurately separated from the quality change. • Boskin = 0.60 / 1.10 (percent points per annum) Statistics Canada • Statistique Canada

  4. The theory • CPI: A consumer price index measures a price change for a constant market basket of goods and services from one period to the next. • A temporal price index (e.g., CPI) should be an estimate of “pure” price change. • Matched sampling is used to “hit” this target. Statistics Canada • Statistique Canada

  5. The theory • Matched sample:a sample in which the items selected for analysis share all properties (characteristics) except that under investigation (price). • MS holds constant the quality of the products that have been selected for the index. • To keep quality changes from influencing the price index, specifications of the articles to be priced are of crucial importance. • In practice, a matched sample is a “dream” and the reality is a “nightmare”. • Products disappear • Products change Statistics Canada • Statistique Canada

  6. The theory • If the disappearance is expected to be short lived then there is no major issue. • If not then a different approach must be used which often consist of replacing the items with a substitute. • If the substitute is of the same quality as the one to be replaced the price of the substitute can be used instead of the old one. Statistics Canada • Statistique Canada

  7. The theory • If there is a difference in quality between the old and the new item then an adjustment is needed. • The next section presents an overview of various quality adjustment methods. Statistics Canada • Statistique Canada

  8. The theory (guiding principles) • Quality is a pervasive concept. • Quality adjustment is more an ART than a science. • Hulten (1997): “from a strictly theoretical standpoint, no natural economic concept of quality exists.” Statistics Canada • Statistique Canada

  9. The theory (guiding principles) • DO NOT assume automatically… • … That all price change is a reflection of the change in quality. • … That products with different qualities are essentially equivalent. Statistics Canada • Statistique Canada

  10. Quality adjustment methods • Explicit (or direct) quality adjustment methods directly estimate the value of the quality difference between the old and new product and adjusts one of the prices accordingly. • Implicit (or indirect) quality adjustment methods estimate the pure price change component of the price difference between the old and new products based on the price changes observed for similar products. Statistics Canada • Statistique Canada

  11. Quality adjustment methods • Implicit QA methods • Direct price comparison • Overlap • Overall mean imputation • Class mean imputation • Linked-to-show-no-price-change • Matched model • Explicit QA methods • Expert valuation • Production costs • Quantity adjustment • Option cost • Hedonics Statistics Canada • Statistique Canada

  12. Jevons price index formula Statistics Canada • Statistique Canada

  13. IMPLICIT QUALITY ADJUSTMENT METHODS Statistics Canada • Statistique Canada

  14. Direct price comparison • A simple approach where the price of the new product in the current period is directly compared with the price of the old product from the previous period. • Assumes no quality difference and the products are perfectly comparable. Statistics Canada • Statistique Canada

  15. 1. Direct price comparison Statistics Canada • Statistique Canada

  16. Direct price comparison: evaluation • In the absence of any information on the new product, it can be the only choice. • Used when the quality difference are subtle or not valued by consumers. Statistics Canada • Statistique Canada

  17. 2. Overlap method • When the old item and the replacement exist simultaneously on the market. • The price change from period t - 1to t is measured using the price of the old item. • The price change from period t to t + 1is measured using the price of the replacement item. • Assumption: The price difference between the old and new products reflect the value of the quality difference. Statistics Canada • Statistique Canada

  18. 2. Overlap method Statistics Canada • Statistique Canada

  19. Overlap method: evaluation • Simple and easy to implement. • Acceptable if it is believed that the price ratio reflects the quality ratio. • This is a reasonable assumption • If your are pricing the same item but in a different store. • Reasonable assumption in competitive markets. • Absence of necessary data • Few quantities available (end-of-cycle) • Perverse results depending on current marketing strategies Statistics Canada • Statistique Canada

  20. Overall mean imputation • When the price of the missing item is not known, an estimate of the price for the missing item is made. • An overlap price is imputed for the old item in the current period by taking the price changes between the previous and current periods of items in the same group. • The replacement’s price changes come into the index only in period 3. • Also called the Imputed price change-implicit quality adjustment method or bridged overlap. Statistics Canada • Statistique Canada

  21. 3. Overall mean imputation Statistics Canada • Statistique Canada

  22. Overall mean imputation: evaluation • The method assumes that the pure price change from the replaced item to the replacement item is the same for the composite of all items in the group. • This may or may not be true depending on the marketing environment at the time of the imputation. • The price change for the item replacement in the sample is imputed from the “pure” price changes of the other items for which their quality did not change. • An implicit quality adjustment is made. Statistics Canada • Statistique Canada

  23. Overall mean imputation: evaluation • The effect is as follows: • If quality is improving then the IP-IQ method misses some price change because it inappropriately counts some price change as quality change. • If prices are rising, it over adjusts for quality change and vice versa. • The direction of the bias depends on the direction of the price change than the direction of the quality change. Statistics Canada • Statistique Canada

  24. Overall mean imputation: evaluation • The method should be used when the prices of the items in sample (the market) react in sync. • Should not be used when the prices of the products fluctuate as a result of market conditions. Statistics Canada • Statistique Canada

  25. Class mean imputation • Same approach as the Overall mean imputation but the price movement for the missing item is imputed from items in the sample of comparable quality. • Same conclusions as the IP-IQ method, Statistics Canada • Statistique Canada

  26. 4. Class mean imputation Statistics Canada • Statistique Canada

  27. Matched model (monthly chaining) • Index is calculated only from the sample of matching items from period to period. • When a replacement is chosen in period t, it is not used in the calculation of the index. • No attempt is made to adjust for any quality difference. • Only the matched items that were in the sample in t – 1 AND t areused. • Generates same result as the IP-IQ method. Statistics Canada • Statistique Canada

  28. 5. Matched model Statistics Canada • Statistique Canada

  29. Link-to-show-no-price-change • With the “link-to-show-no-price-change” it is assumed that any price difference from the old model and the new item is explained by their quality disparity. Statistics Canada • Statistique Canada

  30. 6. Link-to-show-no-price-change Statistics Canada • Statistique Canada

  31. LSNPC: evaluation • The method implies no inflation by assuming that all price change between the old and the new model is the result of quality differences. • The index is biased downward when prices are rising and vice versa. • Method which makes it difficult to isolate the pure price change. • EEC forbids its use. Statistics Canada • Statistique Canada

  32. Results compared Statistics Canada • Statistique Canada

  33. EXPLICIT QUALITY ADJUSTMENT METHODS Statistics Canada • Statistique Canada

  34. Explicit quality adjustment methods • Direct adjustment methods • Option price • Production cost • Expert judgement • Hedonics • More resource intensive compared to Implicit methods. Statistics Canada • Statistique Canada

  35. 1. Direct adjustment Value of the quality difference is $3 Statistics Canada • Statistique Canada

  36. Hedonics • Hedonic price index is any price index, which uses information from a hedonic regression. Hedonic regressions describe how a product’s price could be explained by the product's features (or characteristics). • Hedonics have proven to be very useful when applied to information and communication products (e.g. personal computers), because they can help overcome such problems (or challenges) such as new goods and rapid quality change. Statistics Canada • Statistique Canada

  37. The model and parameter estimates Statistics Canada • Statistique Canada

  38. Hedonics: assumptions • Product characteristics must be quantifiable. • The collection of relevant product characteristics does not change. Statistics Canada • Statistique Canada

  39. Hedonics: issues • Functional form • Multicollinearity • Sample size • Coefficients need to be stable Statistics Canada • Statistique Canada

  40. Hedonics: possible approaches • Estimate the equation and use the coefficients as the “shadow” (or implicit) price of the characteristics. • Estimate the hedonic equation in the base period and use it to estimate the price of the product in the comparison period. The difference in price is explained by quality change. Statistics Canada • Statistique Canada

  41. No Has the quality changed? Continue to use matched sampling Yes Manually assess Yes Use direct adjustment Yes Is a replacement available? Can the quality difference be explicitly quantified? Production costs No Expert panels No replacement available Overall class mean imputation Option costs Replacement available All price difference is due to quality No price difference is due to quality Carry Forward Hedonics Use direct comparison Are the old item and the new items available simultaneously? Yes Linked with no price change No Overlap method Statistics Canada • Statistique Canada

  42. Clothing: the Canadian practice Statistics Canada • Statistique Canada

  43. Before moving on… • Each and every instance of commodity substitution is unique and must be carefully considered to ensure that the aim of measuring pure price change is respected, as far as practicable. • Which method is used to make the quality assessment must also be considered on a case by case basis. • Different approaches generate different results. Statistics Canada • Statistique Canada

  44. Clothing Statistics Canada • Statistique Canada

  45. Monthly clothing indexes. Jan 2001 to Sept 2009 Statistics Canada • Statistique Canada

  46. Monthly clothing indexes. Jan 2001 to Sept 2009 Statistics Canada • Statistique Canada

  47. Statistics Canada • Statistique Canada

  48. Clothing: the issues • The apparel component of the CPI was chosen as the subject of the research described in this article due in part to the difficulty of correctly measuring price change for apparel items and the labor-intensive nature of the microlevel review of price and characteristic data associated with apparel. • Brown and Stockburger, 2007 Statistics Canada • Statistique Canada

  49. Clothing: the issues • The seasonal nature of apparel • The large number of item replacements • The need on maintaining a constant-quality price index • Result: resource intensive exercise Statistics Canada • Statistique Canada

  50. Clothing: the Canadian practice • Direct approach • Field agents collect the prices and the features of the apparel item on a Quality Price Change Report (QPCR). • The analysts at the head office then decide if the substitute is comparable or not to the replaced item. • They also make the quality valuation. • Examples of a QPCR for clothing at Statistics Canada. • It starts with the item specification. Statistics Canada • Statistique Canada

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