Product Innovations, Price Indices and the (Mis)Measurement of Economic Performance

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Abstract
The purpose of this paper is to address the problem of 'product innovations' (i.e. new goods, increased variety, and quality change) in the construction of price indices and, by extension, in the measurement of economic growth. The premise is that a great deal of technological progress takes indeed the form of product innovations, but conventional economic statistics fail by and large to reflect them. The approach suggested here consists of two stages: first, the benefits from product innovations are estimated with the aid of discrete-choice models, and second, those benefits are used to construct 'real' (or 'quality adjusted') price indices. Following a discussion of the merits of such approach vis a vis the use of hedonic price indices, I apply it to the study of a specific innovation, namely CT (Computed Tomography) Scanners. The main finding is that the rate of decline in the quality-adjusted price of CT scanners was a staggering 55% per year (on average) over the first decade following the invention of CT. By contrast, an hedonic-based 'real' index captures just a small fraction of the decline, and worse still, a simple (unadjusted) price index shows a substantial price Increase over the same period. Thus, conventional indices might be missing indeed a great deal of the welfare consequences of technical advance, particularly during the initial stages of the product cycle of new products. It remains to be seen, though, how much of the paradox of explosive technical change on the one hand, and 'low' measured growth rates on the other could be accounted for by this sort of discrepancies.
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