Biasesand the Cost of Living in the US

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Introduction

This essay is on the biases identified by the Boskin Commission in the estimation of fiscal policy and the living standards on people in the US; it was basically an evaluation of the national price statistic. It is formatted in a way that explains on the methods they used to identify these biases and an in depth analysis of how these biases disillusioned the public on their living standards. The extent of the difficulty of the price measurements will also be covered to try and expand on the ways these biases came about and the recommendations given by commission on the ways of eliminating these biases. The commission indicated a wide range of positive improvements in the commodity market in relation to substitution, product quality and new products introduction.

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Overview of Boskin Commission Approach and Methods

The Boskin Commission mainly focused on the analysis and the evaluation of the national price statistic. It was only concerned with the consumer price index (CPI) and the provision of the point estimates of the overall biases in the CPI in the US economy (Moulton, p. 159). The commission members basically divided up the tasks and then incorporating the research by academics, BLS insiders, and others scholars and economists who had covered the issues in the past, this report was basically the review of the past research done by the BLS. They further went ahead to draw numerical conclusions from the research in that they created the point estimate of the overall CPI. This report triggered the changes in the national economic background in the following of the recommendations; it also triggered extensive research on the measurement errors in the estimation of the CPI (Boskin et al., 1996, p. 72). Boskin commission did not make any of its own estimates of the consumer surplus in the valuing of the new products but adopted this method with the exclusion of the explicit dimensions in the quality changes and the introduction of the new commodity or product in the market.

The CPI and Difficulty of Price Measurements

Markets nowadays are characterized by different types and varieties of products in the market which might cause the difficulty in the price determination. There are also new products being introduced now and then in these markets and the existing ones being improved in a frequent manner depending to the ever-changing needs of the consumers and thus the relative prices of these commodities also change frequently. There were a number of reasons as to why the measurements were seen as difficult they include (Shapiro et al, p. 112);

Firstly this ever changing market dynamics made the Boskin commission to indicate that the inflation rates was a factor that was very challenging to measure or estimate in a complex dynamic market economy. There are some assumptions and procedures that are required to measure the level and/or change in consumer prices in the market and thus these had to be established first. The CPI was designed to focus on the consumer expenditures in the disposable income and excluding the non-market activities (Boskin et al., 1996, p. 43).

Secondly the other challenge lies in the indentifying the prices of the commodities and the services you want to measure, the ways to collect of find this information, where to collect it from and its integration with the summary statistics. In all these there are some assumptions and judgments which must be made.

And lastly there are very large number of commodities and services in the market, the challenge was as to how the commission will group these commodities to the final statistic and the assumptions they will make to enable them give a conclusion which cam be adopted by policy and strategy makers in the economic decisions (Boskin et al., 1996, p. 33).

The CPI price collection goes through a hierarchical or pyramidal process. For example, housing is divided into shelter, fuel and other utilities, and household furnishings and operations. Each of these subcategories is divided still further, e.g., household furnishings into categories such as furniture and bedding, appliances, etc. The lowest level of aggregation for which an index is calculated by aggregating price quotes is called an item stratum.

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The enormous amount of journalistic attention given to the Commission’s findings reflects the central role of CPI measurement in almost every major economic issue (Diewert, p. 47). A bias in the growth rate of the CPI contaminates official estimates of growth in output and productivity, median income, and real wages; it alters the growth rates of government tax revenues and spending programs that are indexed to inflation; it has major consequences for the time path of the government budget deficit and national debt; it produces misleading estimates of inflation for monetary policymakers for whom the inflation rate is a critical target; it distorts estimates of poverty rates; and it clouds comparisons of the comparative economic performance of nations.

Biases in CPI Determination

Substitution

Consumer substitution was not accounted for in the previous system which relied on the fixed weights Laspeyres indexes in the determination of the CPI in their analytical and empirical research. These Laspeyres indexes measures of inflation level were upper bound and basically brought about the source of bias to about 0.4 % points annually. From 1999 the CPI adopted the use of geometric weights for most of the lower-level categories commodities and it retained the Laspeyres index for the commodities in the upper-level strata of the index (Braithwait, p. 64).

In the US there have been a number of changes in the nature of retailing with and increase of superstores and discount chains in the localities. The departmental stores accounted for an increase from about 45% in 1988 to roughly 68% in 1998 with cheaper and affordable pricing strategies. This shows that the commodity prices recorded and used for inflation estimation are way beyond the actual prices in the market and thus it does not display the actual inflation rates in the economy.

The data used in the analysis is got from these outlets and since it is not basically used in the calculation of the CPI, thus when there is no indication of the shift of the consumers to prefer consuming from the discounters. In the U.S this bias adds another 0.1 percentage point of upward bias (Boskin et al., 1996, p. 63).

New product and Quality Change

There is a 0.6% bias on the difficulty in the adjustment of the consumer commodity changes in the quality and the entrance of new products in the market. There are also new products being introduced now and then in these markets and the existing ones being improved in a frequent manner depending to the ever-changing needs of the consumers and thus the relative prices of these commodities also change frequently. The COL index has been used by economists in the estimation of the reservation price and the consumer surplus which is attributed to the introduction of new products in the market. Boskin commission did not make any of its own estimates of the consumer surplus in the valuing of the new products but adopted this method with the exclusion of the explicit dimensions in the quality changes and the introduction of the new commodity or product in the market. Some commodities like VCRs, cellular phones etc were incorporated in the CPI index after a long time approximately 10 years since their entrance in the market and their prices had fallen by almost 80% or more in that period.

Research has incorporated the estimation of the biases in the CPI which was brought about by the late introduction of some commodities in the market. The Commission attempted to divide and identify commodity categories which could be used for analysis in which the estimation of CPI and then identifying the extent in which the CPI was biased for its ignorance of the improvements in product quality. This was achieved by the examination of the separate subcomponents of the CPI and then using it to determine the extent of the bias within the 27 selected categories. In this case there was no table indicating the bias caused by the late introduction of the new products in the market and thus this was treated implicitly as an additional bias due to the late introduction of the new products (Boskin et al., 1996, p. 63).

It can be noted that in 8 of the categories analyzed by the commission they discovered that there was no evidence of any bias other than zero. In the other 19 categories the bias ranged from 3.0% annually for medical and hospital services and 5.6% for electronic goods and appliances. In general the overall bias caused by the product quality and the introduction of new product in the market was 0.6% point annually. The commission made a bias in relation to the quality change and the new product introduction, the quality of life was not estimated in any quantitative manner but initiated an informal discussion on the changes of the quality of life caused by these factors which would make the estimate trend very high or very low in the long run (Boskin et al., 1996, p. 71).

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Quality of life assessment

The commission had an assessment of the quality of life on the consumers with an aim to identify the extent in which the consumer’s living standards were biased in the estimation (Gordon, p.56). The Commission’s quality of life assessment criteria concluded that the good attributes have overcome the bad attributes in the estimation and thus the estimate was displaying an estimate close to the actual situation in the economy. Some of the facts which were true in the findings were the reduction of the air and water pollution in the economy, decline in the mortality rates and an increase in the overall life expectancy level in the US (Abraham et al. p. 30).

The commission indicated a wide range of positive improvements in the commodity market in relation to product quality and new products introduction but did not however make any allowances on this,

“The faster speed and reduced vibration of jet planes, improved reliability of appliances and automobiles, improved sound quality of audio equipment in homes and automobiles, improved safety devices on home power tools and power lawn mowers, reduction in the noise, weight, and installation cost of room air conditioners, and immeasurably better picture quality of color TV sets…….” (Boskin et al., 1996, p. 74)

Some of the recommendations of the commission like the introduction of the cable and the satellite TV and the introduction of the internet services was late as it had been common in the domestic market earlier than the time it was initiated in the CPI index. The commission concluded that

” …. the major increase in longevity.. Perhaps swamps everything else. Accordingly, our estimate of the current bias in the CPI is, if anything, probably understated” (Boskin et al., 1998, p. 7).

Conclusion

The Boskin commission findings have changed the economic landscape in terms of the measurements the estimation of the findings and some of its recommendations have been adopted by the state (Hausman, p. 4). The commission indicated a wide range of positive improvements in the commodity market in relation to substitution, product quality and new products introduction. A bias in the growth rate of the CPI contaminates official estimates of growth in output and productivity, median income, and real wages; it alters the growth rates of government tax revenues and spending programs that are indexed to inflation; it has major consequences for the time path of the government budget deficit and national debt. It can be said to stimulate the measurement economic indicators in the economy and thus a proactive attempt was initiated to give the correct information on the actual price indicators.

Works Cited

  1. Abraham, K, John S. Greenlees, and Brent R. Moulton, “Working to Improve the Consumer Price Index,” Journal of Economic Perspectives, 1998, 12(1), pp. 27 – 36.
  2. Boskin, Michael, E. Dulberger, R. Gordon, Z. Griliches, and D. Jorgenson, “Toward a More Accurate Measure of the Cost of Living,” Final Report to the Senate Finance Committee, 1996.
  3. Boskin, Michael J, E. Dulberger, R. Gordon, Z. Griliches, and D. Jorgenson, “Consumer Prices, the Consumer Price Index, and the Cost of Living,” Journal of Economic Perspectives, 1998, 12(1), pp. 3-26.
  4. Braithwait, Steven D, “Substitution Bias of the Laspeyres Price Index: An Analysis Using Estimated Cost-of-Living Indexes,” American Economic Review, 1980, 70:1, 64-77.
  5. Diewert, W. Erwin, “Index Number Issues in the Consumer Price Index,” Journal of Economic Perspectives, 1998, 12(1), pp. 47-58.
  6. Gordon, Robert. The Measurement of Durable Goods Prices, Chicago: University of Chicago Press, 1990.
  7. Hausman, Jerry. “Comment on CPI Commission Report,” 1997 Papers and Proceedings, American Economic Review, Princeton, NJ.
  8. Moulton, Brent R, “Bias in the Consumer Price Index: What is the Evidence?” Journal of Economic Perspectives, 1996, 10:4, 159-177.
  9. Shapiro, Matthew D, and David W. Wilcox, “Mismeasurement in the Consumer Price Index: An Evaluation,” NBER Macroeconomics Annual 1996.

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