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Corrected for Inflation

Posted By Russ Roberts On March 24, 2006 @ 2:30 pm In Prices | Comments Disabled

Studies suggest that measured inflation is overstated because of a failure to control for quality differences. (Here’s one [1] example from Mark Bils at the University of Rochester.) Michael Boskin of Stanford chaired a commission a few years back that found (if memory serves) that the annual error is something on the order of 1% per year. That’s make a huge difference over time when trying to adjust wages or income for inflation to measure changes in the standard of living. If inflation is overstated, then growth in our standard of living gets understated.

USA Today reports [2] on the 25th anniversary of the mountain bike and illustrates the fundamental problem of quality and measuring inflation. When the mountain bike was first introduced, it cost $750. Now, a mountain bike costs $1400. So if mountain bikes are in the CPI, you would say they have almost doubled in price. But as the USA Today article points out, that is less than the average price increase over the same time:

You can still buy a Stumpjumper today — at less than the original cost.
The 1981 price was $750, or $1,537 when adjusted for 25 years of
inflation.

I’m not sure which inflation series the reporter was using. Any calculation I make finds that if the price of mountain bikes had risen at the rate of inflation, they’d cost over $1600.  But the main point is that when the economy-wide inflation rate is calculated, it includes items like the mountain bike. Some prices have risen even more than the price of the mountain bike. Some less. Some have even gone down. The CPI and the rate of inflation are an attempt to calculate an overall average of all goods in the economy.

Suppose the price of mountain bike today had gone up at exactly the same rate as the average of all other prices. Then you’d conclude that the mountain bike had gotten no cheaper and no more expensive in real terms over the last 25 years.

But then there’s the quality problem. As USA Today reports:

Nobody knows Stumpjumpers like Ned Overend. He
won the first-ever mountain bike world championship in 1990 on a
carbon-fiber prototype. In 2004, at age 48, he placed seventh at the
U.S. national championships on a Stumpjumper.

"The bike has changed a lot over the years,"
says Overend, who also won the 1998 and 1999 Xterra Mountain Bike
Triathlon world championships. "In 1990, we couldn’t have imagined the
bikes we ride today."

The first "superlight" Stumpjumper weighed just under 30 pounds, was made of steel and had 15 gears and no shock absorbers.

Most of today’s mountain bikes are 10 pounds
lighter and have a front shock and 27 gears. A FSR Stumpjumper, with
disc brakes and "smart" dual shocks that analyze the terrain, weighs 26
pounds.

So the mountain bike is actually a lot cheaper than it once was, controlling for quality. As I understand it, the Bureau of Labor Statistics has tried in recent years to correct for these improvements. They use what is called "hedonic analysis." In this case that would involve trying to measure how much bike riders value the lighter bike and the shock absorbers and any other improvements and then deducting those values from the price to take the quality improvements out of the measure of inflation.

Obviously, those calculations are difficult to do accurately.

And the $1400 bike today is the low end bike. You can spend a lot more and get even more quality:

Several top-end bikes, such as the $7,100
Specialized S-Works Stumpjumper FSR Carbon, feature "smart" suspension
technology that reads the terrain and adjusts the shock-absorbers to
stiffen for smooth trails or climbing, then soften to suck up bumps and
holes. That bike is the heir to the original Stumpjumper, considered
the first mass-market mountain bike.

Unlike the rigid and finicky early models, the
new bikes allow less-experienced riders to tackle technical terrain
with less risk of a crash.

Other models, such as the $5,500 Trek Fuel EX
9.9, the $3,000 Kona The King and the $7,500 Scott USA Ranson Limited,
give experienced riders several on-the-fly shock settings to squeeze
extra energy from the terrain by compressing the shocks into berm turns
or trail depressions, then releasing that energy for a speed burst.

You can see the challenge for measuring inflation accurately. As we get wealthier, choices proliferate. But as we choose higher and higher quality variations as a result of that wealth, it gets harder and harder to measure how much wealthier we are in real terms. Throwing some of those more expensive bikes into the CPI category called "mountain bike" is really going to distort the estimate of the cost of living.

 

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[1] Here’s one: http://papers.nber.org/papers/w10606

[2] reports: http://www.usatoday.com/sports/cycling/2006-03-22-cycling-bikes_x.htm

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