Consumption (Economics) ; Economic indicators

Peter J. Klenow

English

Research Papers in Economics

 
FEDERAL RESERVE BANK OF ST. LOUIS
 
43
MAY/JUNE 1997
Commentary
Peter J. Klenow
 
In “Measuring Consumption: The
Post-1973 Slowdown and the Research
Issues,” Jack E. Triplett has made many
interesting observations.  I will focus on
two.  First, Triplett notes that U.S. statistical
agencies already incorporate a positive rate
of quality change for many items in the
Consumer Price Index (CPI) and the con-
sumption deﬂator.  Quality improvements
are therefore not being ignored entirely,
and could actually be overstated.  Second,
Triplett voices skepticism about the hypoth-
esis that the slowdown in the growth rate
of consumption, which began in the mid
1970s, reﬂects greater understatement of
the growth rate rather than a real slowdown.
He observes that growth in food consump-
tion has slowed along with growth in other
consumption.  Because real food consump-
tion is measured more accurately than
nonfood consumption, he reasons, the growth
rate of real food consumption should closely
resemble the true growth rate.
ARE QUALITY IMPROVE-
MENTS UNDERSTATED?
On the issue of understated quality
improvements, I will ﬁrst discuss the most
difﬁcult category for which to make the
case, namely cars.  I will then discuss ser-
vices, where the case seems much easier.
Triplett notes that the typical new car price
has risen from about $3,000 in 1966 to
about $17,000 today.  Without any quality
adjustments, the auto portion of the CPI
would therefore have registered roughly 6
percent annual inﬂation from 1966 to
1996.  The CPI for autos, however, has
risen only about 3.5 percent per year
during this period, the difference being
measured quality improvements of 2.5 per-
cent per year.  So the Bureau of Labor
Statistics is saying that a typical 1996 car is
better than a typical 1966 car.  Indeed, 2.5
percent quality change for 30 years would
mean today’s cars are twice as good as 1966
cars. As Triplett emphasizes, the real ques-
tion is whether 1996 cars are more than
twice as good as 1966 cars.  Equivalently,
would the typical person prefer a 1996 model
for $17,000 to a 1966 model for $8,500?
Not being an expert on car models of
any vintage, I checked 
 
Consumer Reports
(May 1996, p. 9).  It compares 1966 and
1996 car models and reports the following:
Mileage has more than doubled, from 13
miles per gallon (mpg) to 27.5 mpg.
Whereas bodies had previously rusted in
two years to three years, current models
resist rust for 100,000 miles.  Tires last
more than three times as long as they used
to (about 12,000 miles in 1966 vs. about
40,000 in 1996).  The 1966 models featured
little safety equipment; whereas antilock
brakes and dual air bags are near standard
in 1996 cars.  In 1966 engines had trouble
starting in cold weather; in 1996 engines
do not.  Finally, major mechanical problems
often surfaced in 1966 models at about
50,000 miles vs. about 100,000 miles for
1996 models.  Consumer Reports concludes,
“You should be glad they don’t make cars
like they used to.  You probably wouldn’t
want one.”
Consistent with the Consumer Reports
conclusion, Gordon (1990) estimates that
the ofﬁcial consumption deﬂator overstated
1947-83 inﬂation for motor vehicles and
parts by 1.7 percent per year.  For durable
consumption goods as a whole, including
household appliances and consumer elec-
tronics, Gordon estimates an annual bias
of 1.5 percent.
HAS SERVICE QUALITY
DECLINED?
How about quality change in services?
Hornstein and Krusell (1996) report
falling total factor productivity (TFP) at
 
Peter J. Klenow is an associate professor of economics in the Graduate School of Business at the University of Chicago.FEDERAL RESERVE BANK OF ST. LOUIS
44
 
1 See Nakamura (1996).
MAY/JUNE 1997
the rate of 1.8 percent per year during
1954-93 in ﬁnance, insurance, and real
estate (FIRE) and 0.6 percent per year in
other services (which includes health care).
Once Hornstein and Krusell incorporate
Gordon’s (1990) adjustments for unmeasured
quality improvements in producer’s durable
equipment (e.g., better computers), inputs
into these sectors rise more quickly: TFP
falls at 2.3 percent and 1.0 percent per year
in FIRE and other services, respectively.
New regulations and possibly deterio-
rating schools notwithstanding, I cannot
imagine that these service industries can
provide only 40 percent and 68 percent as
much service in 1993 as in 1954, with
comparable inputs.  More plausibly, TFP
has not declined in these sectors and
quality has improved more than is being
measured.  A recent study provides some
corroboration for this hypothesis.  Cutler,
McCellan, Newhouse, and Remler (1996)
estimate improvements in heart attack
treatment between 1983 and 1994.
Whereas the CPI for such treatment rose
3.4 percent per year more quickly than the
overall CPI, Cutler et al. estimate that the
real cost of living (quite literally, in terms
of years of life gained through treating a
heart problem) fell 1.1 percent per year,
relative to the overall CPI.
A related piece of evidence is the
rising share of services in consumption
and in gross domestic product (GDP).
Between 1963 and 1993 the share of FIRE
in GDP (in current dollars) rose from 14
percent to 19 percent, and the share in
other services rose from 10 percent to 20
percent (NIPA data, Citibase).  Why are we
shifting toward services if they are becoming
relatively more expensive?  Price-inelastic
demand is one possibility, but the shift has
occurred even in constant dollars.  Many
services are luxuries (i.e., consumption
elasticities above one), but the shift toward
services has accelerated since the mid 1970s,
while the measured aggregate growth rate
has declined.1 Changing demographics
could be part of the story; one could inves-
tigate this hypothesis using the Consumer
Expenditure Survey.  These alternatives
cannot explain why the shift has also
occurred for producer services.
A possibility worth entertaining is that
services have been improving in quality,
especially since the mid 1970s.  As with
heart attack treatment, the quality-adjusted
price of services may be declining rather
than rising relative to the prices of other
goods.  To make things concrete, consider
the following example (from my preliminary
work with Mark Bils of the University of
Rochester).  Consumers choose quantities
of food (YF) and services (YS), taking prices
(PF and PS) and the quality of services (
 
Q)
as given.  Consistent with Triplett’s
argument, treat food as the well-measured
comparison good.  Utility takes the form
(1)  
where 
 
s>1 is the elasticity of
substitution between food and services.
(This specification would not make sense
if s<1, because then higher quality
reduces utility.  To entertain inelastic
demand, a different functional form
would have to be used.)  This single
parameter formulation imposes equal
income elasticities for services and food,
but the results are reinforced if the Engel
curve is steeper for services since the
growth rate of total consumption fell
after the mid 1970s.  Utility maxim-
ization requires that the ratio of marginal
utilities be equated to the ratio of
marginal products, or
(2)
Taking log ﬁrst differences and
rearranging yields
(3)  
In the data, quantities are shifting
toward services (
 
DlnYS > DlnYF) even
though services are becoming more expen-
sive (DlnPS > DlnPF). As Equation 3
indicates, this can be rational behavior if
 
D D D
D D
ln ln ln
ln ln .
Q Y Y
P P
S F
S F
= - ( )
+ - ( )
1
s
Q Y
Y
P
P
s
F
s
F
*
=
-
-
1
1
/
/ .
s
s
Utility
Q Y Y s F =
* +
-
- - 1 1 1 1
1 1
/ /
/
,
s s
sFEDERAL RESERVE BANK OF ST. LOUIS
45
MAY/JUNE 1997
the quality of services is improving (DlnQ
> 0).
To give quantitative life to this exam-
ple, I use data from the 1996 Economic
Report of the President (Tables B-12 and B-
13) on the levels of nominal and real
(1992 dollars, chain-weighted) consump-
tion of services and food in 1960, 1975,
and 1990 and suppose that s= 1.5.  Plug-
ging in the relevant number yields
(4)
and
(5)  
In this example the “Quality Residual”
rose 1 percent per year from 1960 to 1975
and accelerated to a 2.6 percent annual
clip from 1975 to 1990.  The rate of quality
improvements accelerates to explain why
relative quantities kept shifting smartly
toward services when relative price trends
moved against them.  So, in the same way
that inputs are pouring into services with
little measured output gain (falling TFP),
consumers are pouring into services with
little measured utility gain.  Just as the
TFP puzzle could be explained by rising
quality, the utility puzzle could be explained
by rising quality.  These calculations are
robust to substituting gasoline for food, as
well as substituting nonfood (or nongaso-
line) consumption for services.  Such
calculations are also robust to using the
CPI rather than the consumption deﬂator.
Of course, it is hazardous to label a residual.
The Solow residual, for example, does not
solely reﬂect technology.  But this example
illustrates that consumer behavior might
suggest substantial quality improvements.
IS CONSUMPTION GROWTH
SLOWING?
This discussion brings me back to
Triplett’s contention that the slowdown in
consumption growth is likely to be real
rather than imaginary, given the almost
commensurate slowdown in well-
measured food consumption.  As the
preceding illustrates, the slowdown in
food consumption should be commen-
surate only if the trend in relative food
prices did not change (ignoring differing con-
sumption elasticities).  In fact, food went
from rising 0.5 percent annually in price,
relative to services, during 1960-75, to
falling at a 1.5 percent rate during 1975-
90.  So if a substantial growth slowdown
occurred, we would not expect it to hit
food as hard as services.  (This point is
reinforced if the consumption Engel curve
is steeper for services than for food.)  That
is, taking substitution effects into consid-
eration, a puzzle arises as to why food
consumption growth slowed down so much.
If the solution to the puzzle is that services
improved in quality 1.6 percent faster after
1975, then part (but not all) of the slowdown
would be a ﬁgment of growing mismeasure-
ment.  Relatedly, Hornstein and Krusell
(1996) document a steady increase in the
GDP share of “unmeasurables,” such as
services, and argue that the increase would
directly contribute to growing understate-
ment of real growth.
I end my comments by noting that a
greater variety of goods from which to
choose is much like higher quality.  Con-
sumers can choose their “ideal” variety
(e.g., a minivan if they have a lot of chil-
dren) or rotate varieties (e.g., breakfast
cereals), thereby receiving more utility
from a given expenditure than if fewer
varieties were available from which to
choose.  Quantifying variety gains is very
difficult.  It requires detailed data on the
degree of substitutability between new
and existing varieties, but some success-
ful attempts have been made.  Berry,
Levinsohn, and Pakes (1995) estimate the
substitutability of different U.S. car
models, and could quantify variety gains
from the growing number of models
available.  Hausman (1997), after
estimating the consumer surplus created
by the introduction of Apple Cinnamon
Cheerios, conjectures that the growth rate
of the CPI’s cereal component may be
overstated by about 2 percent per year
1975 1990 2 6
3 4 1 8 1 5 6 6 5 1
- =
= - ( ) + - ( )
Dln . %
. . / . . . .
Q
1960 1975 1
4 4 2 2 1 5 3 9 4 4
- =
= - ( ) + - ( )
Dln %
. . / . . . ,
QFEDERAL RESERVE BANK OF ST. LOUIS
46
MAY/JUNE 1997
because it neglects the variety benefits
from new cereal brands.  With growing
availability of scanner data, variety gains
may become quantiﬁable for many more
goods.
REFERENCES
Berry, Steve, James Levinsohn, and Ariel Pakes.  “Automobile Prices in
Market Equilibrium,” 
 
Econometrica (Vol. 63, No. 4, 1995), pp. 841-90.
Consumer Reports (May 1996).
Cutler, David M., Mark McClellan, Joseph P. Newhouse, and Dahlia
Remler.  “Are Medical Prices Declining?” NBER working paper, No.
5750, 1996.
Economic Report of the President.  U.S. Government Printing Ofﬁce, 1996.
Gordon, Robert J.  The Measurement of Durable Goods Prices, University
of Chicago Press, 1990.
Hausman, Jerry A.  “Valuation of New Goods Under Perfect and
Imperfect Competition,” The Economics of New Goods, Timothy F.
Bronaham and Robert J. Gordon, eds., University of Chicago Press,
1997, pp. 209-48.
Hornstein, Andreas, and Per Krusell.  “Can Technology Improvements
Cause Productivity Slowdowns?”  1996 NBER Macroeconomics
Annual, MIT Press, 1996, pp. 209-59.
Nakamura, Leonard I.  “Is U.S. Economic Performance Really That
Bad?”  Federal Reserve Bank of Philadelphia working paper, No. 95-
21/R, 1996.

Automobile Prices in

Can Technology Improvements Cause Productivity Slowdowns?”

Economic Performance Really That Bad?” Federal Reserve Bank of Philadelphia working paper,

The Measurement of Durable Goods Prices,

Measuring consumption: the post-1973 slowdown and the research issues - commentary

http://research.stlouisfed.org/publications/review/97/05/9705pkl.pdf

Measuring consumption: the post-1973 slowdown and the research issues - commentary

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics