Hedonics: Putting a Price on Progress

Ever wondered why your household expenditure keeps going up by more than inflation? Grocery bill not moving in line with the RPI? A little known component of many governments’ official inflation figures is their application of hedonic adjustments. This aims to take account of a change in quality of any component within the basket of goods used to calculate the CPI, by discounting (or inflating) the price of that component to reflect the change in specification.

Example 1: a new smartphone. Well the sticker price may be 10% higher than the previous model, but when adjusted to take account of its faster processor, higher resolution screen, better camera, yadda, yadda, yadda, its value within the basket is barely changed.

Example 2: a new car. Its more powerful, economical engine, better brakes, extra airbags, better satnav and improved stereo all have a value ascribed to them, which are then deducted from the new nominal price to arrive at the “true” rise in price.

In fairness, it also works the other way. For example, the fact that the size of Mars Bars and Cadbury’s Creme Eggs, or the contents of Smoky Bacon crisp packets seems to be shrinking by the year (how annoying is that, by the way?) means that their prices are adjusted upwards when the stats are calculated.

For the most part, however, technological advances in things like electronic goods (according to Moore’s Law, processing power doubles, and therefore its cost halves, every 18 months), along with items like TVs, washing machines, broadband services, medical care, cinema tickets, computer software, far outweigh the impact of smaller Chocolate Digestives on the average household.

So far, so what? I hear you ask. Why does this matter? Well, firstly, progress in unavoidable – let’s face it “NEW AND IMPROVED” tends to crop up in manufacturers’ sales blurb a little more often than “not as good as our last one”. Second, as consumers, we have no choice – we simply can’t buy the older, cheaper model, even if we really wanted to.

So why bother with hedonics at all? With large chunks of western governments’ expenditure items linked to the CPI – welfare, pensions, public workers’ salaries, interest on inflation-linked bonds – there is a clear incentive for governments to do whatever they can to supress the official rate of inflation by as much as they can.

So while official government sources will tell you that such price adjustments have a negligible impact on inflation numbers, typing in “hedonics” to your favourite internet search engine will find no shortage of commentators and conspiracy theorists who say otherwise (top tip: careful with the fat fingers: mistakenly typing in “hedonISM” will take you to a very different place!). Indeed, estimates of their long-term impact vary from annualised figures of 0.5% or 1% to as much as a third of the official inflation rate. While this writer wouldn’t wish to be seen to align himself with the “tin foil hat brigade” too often, I certainly know which version I’m inclined to believe.