Hedonic quality adjustments are made to the CPIs of many goods and services but have a particularly big impact on those with the latest and greatest always evolving technologies.

By Wolf Richter for WOLF STREET.

“Hedonic quality adjustments” play a big role in the difference between actual price increases of new and used vehicles and the increases in the Consumer Price Index for new and used vehicles. For many years up to the pandemic, the CPI for new vehicles remained roughly flat while prices of new and used vehicles surged.

The WOLF STREET F-150 XLT and Camry LE Price Index shows the MSRPs of both models going back to 1990. I use the base version of these models, with no add-ons and without destination and delivery charges, to show the price increases of the bestselling truck and the best-selling car in the US going back to 1990. And I compare that to the CPI for new vehicles.

This chart is a visual depiction of how hedonic quality adjustments keep the CPI down, while retail prices surge. F-150 XLT (red, left scale), Camry LE (purple, left scale), and the Consumer Price Index for New Vehicles (green, right scale).

The Bureau of Labor Statistics, which produces the CPI, started applying hedonic quality adjustments with increasing aggressiveness in the late 1990s.

Not just to new and used vehicles, but also to consumer electronics, appliances, and lots of other manufactured consumer products, such as some clothing, plus some services, such as housing and internet access (which went from dialup to 10 gigabit broadband in 25 years).

Hedonic quality adjustments are not applied to food and certain other products and services ( the BLS list of product categories is here).

The logic is that these products have gotten a lot better over those years, for example, going from three-speed automatic transmissions to 10-speed computer-controlled transmissions. The hedonic quality adjustments remove the costs of these quality improvements from the CPI.

Price increases that consumers have to deal with consist of many factors, including:

• Loss of the purchasing power of the dollar
• The costs of quality improvements, for example going from a 3-speed automatic transmission to a 10-speed electronically controlled transmission, or going from a 1995 Motorola cellphone to a current-model iPhone.
• Profit margins of the producer
• Input costs, labor costs, etc.

But only the loss of purchasing power of the dollar (inflation, a monetary phenomenon) is what the Consumer Price Index attempts to show. The BLS does not want to measure the costs of quality improvements.

To measure that monetary phenomenon of inflation, the CPI attempts to track how many dollars you have to pay for the same product over time.

But the Motorola cellphone from 1995 is not the same product as the current iPhone. Dialup internet access in 1995 is not the same service as 10-gigabit broadband today.

To isolate the loss of purchasing power of the dollar from the costs of quality improvements, the BLS removes the estimated costs of those quality improvements and calls that removal process “hedonic quality adjustments.”

This process has suppressed the CPI for new vehicles over the past 25 years, even as actual prices in dollars of new vehicles have soared.

This process also caused the CPI for consumer electronics products to decline nearly every year. The decline is further accelerated by the fact that consumer electronics have gotten cheaper over time, such as big-screen TVs and laptops, even as the performance and other quality measures improved.

Conceptually, it makes sense to remove the costs of quality improvements from the index that tracks the monetary phenomenon of inflation.

But even if hedonic quality adjustments are calculated properly, without a political agenda to distort CPI downward, it puts the consumer in a bind because at the lower 60% of the income scale, wages have barely kept up with the overall CPI, but have not nearly kept up with the price increases deemed to be due to quality improvements.