Hedonism in the time of inflation

The Bureau of Labor Statistics released its monthly consumer price index today, showing a modest 0.2 percent increase, the first rise in three months and pretty much in line with what economists expected.

That’s called a ho-hum headline. Luckily, the back story is far more interesting.

The BLS compiles the index by surveying prices on more than 80,000 products and services, including everything from food and housing costs to health care and transportation, even “other” stuff like smokes and haircuts. The samples are then weighted by region and adjusted to reflect quantity fluctuations – a price collected for 10 eggs, say, and not the full dozen that was surveyed the month before.

(Even I can do the math on that one.)

Then comes what the bureau calls the hedonic quality adjustment. Yes, that’s the same “hedonic” that stems from the Greek word for pleasure, in this case, the pleasure the consumer would get from the product purchased. The adjustment is necessary because of the bureau’s need to statistically track quality and account for month-over-month changes to it.

Say, for example, Sony decided to discontinue its 60-inch flat screen TV and, darn, that was the exact model the BLS had in its market basket. The bureau could easily select a replacement – an Insignia model, say – but how to adjust for the hedonic regression, the drop in pleasure a consumer would get from owning an Insignia instead of a Sony? Simple:

Where PB,t+s-1 is the quality adjusted price, PA,t+s-1 is the price of Item A in the previous period, and is the constant e, the inverse of the natural logarithm, exponentiated by the difference of the summations of the ßs for the set of characteristics that differ between items A and B. The exponentiation step is done to transform the coefficients from the semi log form to a linear form before adjusting the price.

Multiply that by the 80,000 items in the market basket and you get … well, they get fiscal policy.

I get a headache. — John Kominicki