What is the hedonic method and why is it sometimes used to track changes in the consumer price index? Case Study assignment for Macro Econonomics.

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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First of all, we should note that the hedonic method is used not so much to track changes in the consumer price index (CPI), but rather to adjust the CPI to make it more accurate.  In order to see how and why this is so, let us first look at what CPI is and how it is derived.

The CPI is meant to be a measure of the cost of living in the United States at any given time.  It is used to track inflation.  The CPI is derived from the cost of a given “market basket” of products and services that people typically need to buy.  In other words, a set of goods and services is made up and the prices of those goods and services are determined.  This is used as a baseline.  As the prices of those goods and services changes, so does the CPI.

But there are problems with using the CPI as a measure of the cost of living.  The problem relevant to this question is the fact that the characteristics of the goods and services in the market basket might change.  When the characteristics change, the price can change as well.  This price change might show up in the CPI even though it is really caused by a change in the product, not by inflation.  Let us look at an example of this.

Let us imagine that one thing that is in the market basket is men’s shirts.  In the summer, these are likely to be short-sleeved shirts while in the winter they are long-sleeved.  The long-sleeved shirt will cost more because it has more fabric in it.  This will make the CPI go up a bit from summer to winter, but the change is due to the characteristics of the product, not to inflation.

As another example, let us think about electronic equipment like smart phones.  When the price of a smart phone goes up, it might be because a new model has come out that has better features than the previous one.  In such a case, the price is going up, but so is the value of the product.  Once again, the increase in price is being caused by the characteristics of the product, not by inflation.

Examples like this are why the hedonic method is needed.  The hedonic method is a technique used to factor in the changes in quality in the goods that make up the CPI.  The hedonic method tries to determine how much of the change in the price of the goods is due to changes in the quality of the good and how much is due to inflation.  By doing so, the hedonic method makes the CPI more accurate.  So, we can say that the hedonic method is a method of adjusting the CPI to account for changes in the products that make up the market basket.  It is used because the quality of these products can change over time. 

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