6440.0 - Information Paper: A Guide to the Consumer Price Index, 1998  
ARCHIVED ISSUE Released at 11:30 AM (CANBERRA TIME) 15/02/1999   
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Contents >> Chapter 2. What is the CPI? >> Example: adjusting for quality

To illustrate the process used to adjust for changes in the quality of items priced in the CPI, consider the case of a change in the size of a can of tomato soup. In this example, Acme brand tomato soup is priced in three periods (1, 2 and 3) and the size of the can is reduced from 440gms to 400gms between period 2 and period 3:


Period 1

Period 2

Period 3

    Price:   $1.50
$1.75
$1.70

Using the observed prices produces the following measures of price change:

    Period 1 to Period 2

    Period 2 to Period 3

    Period 1 to Period 3
    (1.75 – 1.50)/1.50x100
    (1.70 – 1.75)/1.75x100
    (1.70 – 1.50)/1.50x100
    = 16.7%
    = – 2.9%
    = 13.3%

However, this does not provide a measure of ‘pure’ price change because the item priced in period 3 is not identical to the item priced in the previous periods. What is required for period 3 is the ‘price that would have been paid for the item that was priced in period 2’. This price can be estimated by adjusting the period 3 price by the ratio of the item's weight in period 2 to its weight in period 3; giving a quality adjusted price of $1.87 ($1.70x440/400).

Using this adjusted price in period 3 results in the following correct measures of price change:

    Period 1 to Period 2

    Period 2 to Period 3

    Period 1 to Period 3
    (1.75 – 1.50)/1.50x100
    (1.87 – 1.75)/1.75x100
    (1.87 – 1.50)/1.50x100
    = 16.7%
    = 6.9%
    = 24.7%

After adjusting for the reduction in quality between periods 2 and 3, the fall in the observed price of 2.9% has been translated into a pure price increase of 6.9%. Similarly, the measure of price change between periods 1 and 3 has been increased from 13.3% to 24.7%.






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