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A Note on Quality and GDP Numbers

My friend Steve Pejovich, emeritus professor of economics at Texas A&M, asks me (by e-mail) the following question in response to this earlier post:

I thought that the price of car that needs no tuning captures improvements that drivers once paid for (relative to what the price would have been if tuning were needed).

Steve’s point is solid, and it reveals that matters are a bit more complicated than I implied in my post.

I assumed in my post that competition drives rival automobile manufacturers to improve the quality of their cars with no corresponding increase over the long-run in the real price of cars.  This assumption, while not implausible for many quality improvements (and not implausible for the particular quality improvement that I mention in my earlier post), is not necessarily descriptive of reality.  What likely occurs in reality for many or even most quality improvements is that much of the costs of supplying these improvements are incorporated into higher-than-otherwise prices of cars.

Consumers are still made better off, of course, because (if these quality improvements prove profitable for automakers to supply) the value that consumers attach to this improved quality is greater than the higher real prices they pay for this improved quality.  Nevertheless, it’s true that improved quality can be and undoubtedly often is reflected in higher real prices per identifiable unit of each of the goods in question (e.g., “automobiles”).

That said, there’s also no reason to deny that a great many product-quality improvements are not reflected in higher real prices.  As technology improves, the competition among firms for market share can well eventually result in higher-quality consumer products without any, or only a very small, consequent increase in the real prices of those products.  Just as competition as described in textbooks causes firms to pass along to consumers exclusively in the form of lower prices any reductions in firms’ costs of production, in reality competition can cause firms to pass along to consumers exclusively in the form of higher quality any greater abilities that firms seize, create, or happen upon to compete for consumer patronage.  (Indeed, competition in reality can cause firms to pass along as product-quality improvements their lower costs of producing their current lines of outputs.  If firms’ costs of producing today’s line of widgets fall – say, because of lower materials costs – there’s nothing in economic theory that says that firms must pass along those lower costs exclusively in the form of lower prices charged for current widgets.  Those lower costs might well be passed along to consumers exclusively in the form of improved widget quality.)

I want to say more on this matter, but must run now to a faculty seminar.  I close here by recommending a much-neglected but very valuable book by Lawrence Abbott, his 1955 volume Quality and Competition.


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