Session on adjusting for
quality change
27th Voorburg Group Meeting
Warsaw, Poland
André Loranger
October 1, 2012
Goal of this session
 This session is a continuation of last year’s
discussion on quality change. The objective of
the session are:
1. Review the issues raised at last year’s meeting.
2. Present and discuss the paper and the outcome of
the consultation with price experts.
3. Outline and discuss options for moving forward on
quality adjustment issues.
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Outstanding questions and
recommendations, VG 2011
 Advertising and Air Transport
• Main question: Should consumer utility or changes to
the production function be the basis for the quality
adjustment for SPPIs?
• Outcome and recommendations: The majority present
supported the practice of only quality adjusting for
changes in the production function while a minority
supported considering consumer utility.
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Outstanding questions and
recommendations, VG 2011
 Distributive Trades (wholesale and retail services)
• Main question: Should the good being traded be quality adjusted
when adjusting the service?
• Outcome and recommendations: No consensus regarding
whether quality adjustments should be made to the goods resold
when calculating a margin price index. Countries should instead
consult with their own SNA for direction.
 The Ottawa Group on Price Statistics should be
consulted on matters pertaining to quality adjustment
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Consultation with CPI Experts
 The Ottawa Group did not meet over the last
year instead a paper summarizing the issues
was written and presented at the UNECE-ILO
meeting of the Group of Experts on Consumer
Price Indices in Geneva, Switzerland this spring.
• As part of the institutional review process, the paper
was reviewed was by several price experts including
members of Statistics Canada’s Price Measurement
Advisory Committee.
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Summary of Geneva paper
 Provided background on PPIs, the Voorburg Group and
VG discussions on quality change
 Summarized the issues and discussion from VG 2011 for
Air Transport, Advertising and Distributive Trades
 Expanded arguments for the production function view
 VG 2012 version of the paper also discusses
recommendations from Geneva and a potential way
forward for the VG
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Expanding the arguments for the
production function view
 Utility curve example, achieved vs. expected
audience size
 Discrepancy between producer and consumer
valuations of quality, aircraft seat example
 Triplett argument for resource-cost view
 Distributive trades, QA for service or good or
both
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Utility and production functions
 P is surface that traces out all
combinations of 2
characteristics Z1 and Z2
 q is indifference curve that
maps out all combinations of
Z1 and Z2 that the consumer is
indifferent against purchasing
 S is production function
(combination of inputs and
technology
 Service delivery occurs at A,
the intersection of the optimal
production and utility at a given
price
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Utility and production functions
“Expected Audience” example

In Q1,
•
•

In Q2,
•
•



9
P = 1000
Expected audience = 1 M
P = 1500,
Expected Audience = 1 M
P = f(Expected Audience)
Achieved Audience does not
factor into production or
consumption decision, although it
may lead to greater consumer
utility
Don’t adjust for audience size,
pure price effect
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Utility and production functions
“Achieved Audience” example

In Q1,
•
•

In Q2,
•
•



10
P = 1000, Achieved Audience = 1 M,
PperAchievedViewer = 0.001
P = 1500, Achieved Audience = 1.5 M
PperAchievedViewer = 0.001
P = f(Achieved Audience)
Achieved Audience is a price
determining characteristic,
therefore must adjust for quality
What is the appropriate basis for
making the adjustment? Potential
discrepancy between producer
and user valuations.
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Discrepancy between producer and
consumer valuations of the QA
Aircraft seat example
2009
2010
Observed
price (£)
SPPI
140
126
Quality
adjustment
(£)
14
Quality
Adjusted
Price (£)
140
140
Price
index
SPPI
100
100
Observed
Turnover
(£)
5,000,000
5,250,000
 Change in configuration of
Derived
(constant
price)
output
5,000,000
5,250,000
Change
in
volume
5.0%
aircraft, increase number of
seats (smaller), change in
production function
 Leads to a decrease in
operating costs and a decrease
in price
 To deliver same level of
quality, firm needs to increase
price by 14 (QA)
 Leads to increase in volume
 Consumers place more value
2009
2010
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Observed
price (£)
CPI
140
126
Quality
adjustment
(£)
28
Quality
Adjusted
Price (£)
140
154
Price
index
CPI
100
110
Observed
Consumer
Expenditure
(£)
5,000,000
5,250,000
Derived
(constant
price)
expenditure
5,000,000
4,772,727
Change
in
volume
-4.5%
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on leg room than the QA
estimated from the producer
side. A QA of 28 is required to
get back to same level of
quality.
 Translates into a 10%
increase in CPI
 Leads to decrease in volume
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Air Transport, Additional thoughts
 Unit value (Revenue per flight) is one of the
recommended approaches for measuring price
change in this industry
 Production function approach to QA fits well with
this model.
• Quality change based on changes to inputs (seating
configuration, flight crew, etc., fuel, etc.)
• Fix quality of the flight, not the individual consumer.
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Discrepancy between producer and
consumer valuations of the QA
Aircraft seat example, continued
The supply-demand identity for a given product or service in the SNA is:
Supply =
output + imports + transport margin + trade margin + taxes – subs. on products
=
intermediate consumption + final consumption expenditure + gross capital
formation + exports =
Demand
Assuming that consumers purchase 100% of the output and that there are no
margins or taxes, it follows that:
output = final consumption expenditure
Identity cannot be resolved in real terms if PPI and CPI are different
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Additional thoughts
 From Jack Triplett, “Concepts of Quality in Input and Output Price
Measures. A Resolution of the User Value Resource-Cost Debate.”
• There are two different uses of the data (input measures and output
measures) and that input and output price indexes imply different
theoretical price index treatments.
• In a resource cost view, the cost of making a machine is the proper
basis for making quality adjustments, not the productivity of using these
machines to produce other goods.
 “The principal conceptual basis for the output PPI is the fixed-input
output price index (FIOPI). The output PPI thus aims to measure an
output price index constructed on the assumption that inputs and
technology are fixed.” PPI manual, 7.44
 Resource-cost view is conceptually consistent with the Fixed-input
output price index (FIOPI), therefore quality adjustment based on the
production function would seem to be appropriate for SPPI
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Wholesale and Retail Services
Quality adjusting goods or service portion?
 SNA output definition excludes the good
• The recording in the SNA of transactions for wholesalers and retailers
does not mirror the way in which those involved view them. The
purchases of goods for resale by wholesalers and retailers are not
recorded by these units explicitly, and they are viewed as selling, not the
goods, but the services of storing and displaying a selection of goods in
convenient locations and making them easily available for customers.
This partitioning measures output for traders by the value of the margins
realized on goods they purchase for resale. (SNA 2008, 3.68)
 If output definition excludes the good then QA
should not be carried out on the underlying good.
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Wholesale and Retail Services
Quality adjusting goods or service portion?
Example:
 V = value, P= price, Q = quantity, V = P x Q
 10 widgets produced by manufacturer and sold to a consumer by a
wholesaler/retailer
 Produce price of widgets = $10
 Final purchase price of widgets = $15
Output
16
V
P
100
10 (PPI)
Q
10
+
Trade Margin
50
5 (15-10) (Margin
Price)
10
=
Final
Consumption
150
15 (CPI)
10
 Example shows that margins are additive in terms of value and
price
 The margins and margins prices are mark-ups on the output and
output prices. They exclude the value of the good.
 Quality adjustment for the margin index should exclude any
adjustment for good because the good is netted out of the margin
calculation.
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Recommendations from Geneva
 Interactions between various international groups are
seen as positive as they encourage dialogue and
different perspectives
• “It was found useful to exchange experiences on the approaches used
for SPPI and CPI. One example of an area where exchange of views
would be useful is the different perspective on quality adjustment in PPIs
based on production functions and technology and CPIs based on utility
functions.”
 Very little specific feedback was received from the Expert
Group on CPI. Possible reasons include:
• Complex topic
• Short discussion
• Paper and presentation not clear
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Way forward for VG
 Further work on this topic is required
 Dichotomy between producer view and consumer view
 Despite the arguments put forward here, for some
services, intuitively it seems reasonable to adjust for
quality based on consumer utility rather than the
production function.
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Way forward for VG
 In deciding which approach is best, we need to consider how
the service is consumed and by whom
 Basic proposal
• If consumption of output mainly by final consumer, adopt
utility approach for QA
• If consumption of output mainly intermediate use, adopt
production function view
• Incorporate the analysis and findings in sector paper to
eventually cover all ISIC industries under VG mandate
Service (ISIC)
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Disposition of use
(consumer
expenditure,
intermediate use)
Approach
(consumer utility
or production
function)
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Method
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Discussion
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