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6419.0 - Producer and International Trade Price Indexes, 1995  
Latest ISSUE Released at 11:30 AM (CANBERRA TIME) 13/02/1995  Ceased
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Contents >> Chapter 14. Treatment of quality change

Introduction

14.1. The objective of ABS price indexes is to measure pure price change over time, i.e. to measure the extent to which the cost of an identical basket of goods changes over time, not affected by changes in quality or quantity or the terms of sale. This is often referred to as pricing to constant quality and is not a simple objective to achieve because the characteristics of goods being sold in the market place, and their terms of sale, change over time. Frequently the precise commodity priced in one period is no longer available in the next period because either there has been some change in the characteristics of the commodity or else something new has taken its place. For price index purposes it is necessary to devise techniques to identify quality differences and eliminate their effect on prices from the calculations of price change for inclusion in the index.


The concept of quality

14.2. The main factors considered in making assessments of quality change in ABS price indexes are how changes in a commodity specification effect purchasers' utility and the cost of actually producing the item in question. The latter is often used as a guide to the former where purchasers' utility is difficult to assess directly.

14.3. For goods where quality is closely associated with the quantitative characteristics of the product, an assessment of quality change is relatively straightforward as these characteristics can usually be measured objectively. For example, if a $4.00 box of chocolates increases in price by $1.00 and the quantity of chocolates also increases by 25 per cent it is easy to see that no price change has occurred from a user value point of view. Quality change becomes much more difficult to assess where it is not purely quantitative or involves a number of quantitative variables which may conflict in terms of their effect on quality. For example, it would be difficult to determine whether there is a net increase or decrease in value to the purchaser in the case of an increase in the power of a car engine which may improve performance but also increase fuel consumption.


Styling and packaging changes

14.4. Product changes that are regarded purely as styling changes are not generally considered to be quality changes. For example, the current year's range of bricks is regarded as being equivalent to last year's if the general quality of workmanship and function is similar, regardless of the actual colour, texture, etc. Similarly, styling changes of a non-functional nature in other products, such as changes in the external trim on an escalator, are not regarded as quality changes. This approach is adopted because it is not considered possible to estimate an objective value for something as subjective as a change in styling.

14.5. Changes in packaging that do not affect the quality of the contents of the package are regarded as having no effect on quality. However, a different type of packaging for building materials, for example, which results in the product incurring less damage while being transported would be taken into account as a quality change.


Identifying changes in quality

14.6. In order to identify changes in quality it is necessary to collect a considerable amount of detailed information about the goods being priced. Some of this information is obtained in the course of collecting and checking prices data during compilation of the price indexes. Instances of unexplained price change are checked to determine whether they represent a genuine price change or a change in quality.

14.7. The most important source of information on quality changes, and the one which produces the information earliest, is interviews with manufacturers, importers or wholesalers of goods included in the indexes. Throughout the year information about forthcoming changes in products is obtained during personal interviews with the businesses. Likely quality changes are also detected from a careful study of articles and advertisements in trade publications, industry newsletters, etc.


Taking account of quality changes

14.8. Whenever it is determined that a change in quality has occurred in a product being priced, the aim is to eliminate the effect that the quality change has on the price, without interfering with the measurement of any true price movement that might have occurred over the same period. The way in which this is done depends on the circumstances in which the quality change occurs. Essentially there are three different situations:

      • Overlapping sales - where one product is replaced by another of different quality, but both have been sold during an overlapping period;
      • Not sold at same time - where one product is replaced by another of different quality, but the two have not been available at the same time; or
      • Change in composition - where there are some changes in the composition of a particular product.

Overlapping sales

14.9. The first situation typically arises where the particular brand, model, etc., being priced ceases to be available but there is another similar item which has been, and continues to be, available in the same market as the first one and is expected to be a substitute for the first one. In this situation, provided the two items have sold side by side for some time in the same market and both have sold in reasonable quantities, the approach is to collect prices for both items at the one date and to assume that the difference in prices represents the difference in quality between the two. The implicit assumption is that the market has adequate knowledge of the qualities and prices of each product and that the difference in price is regarded by them as a reasonable measure of the difference in quality. The second item is then substituted for the first using the technique of splicing price series, as illustrated below:


Period 1
Period 2
Period 3

Price of:
Harvester A
$80000
$85000
Harvester B
$95000
$98000

Price relative for harvesters
100.0


= 106.3
= 109.7


Thus, the price movement reflected in the index from period 1 to period 2 is the movement in the price of Harvester A. The price movement from period 2 to period 3 is based on Harvester B, which will be priced in subsequent periods to replace Harvester A. The difference in price between Harvester A and Harvester B has been eliminated through the process of splicing the new price series to the old price series.

14.10. In some cases, even with overlapping sales, simple splicing of the price of the new specification to the existing price series is not a satisfactory way of eliminating changes in quality. This situation occurs, for example, when the price of a new model reflects not only the extent of modifications but also a degree of price change, upwards or downwards, for reasons quite distinct from these modifications. In these circumstances, a simple splicing of the old and new prices would eliminate the elements of pure price change as well as the elements of change in quality. In such cases, it is necessary to assess the degree of pure price change involved and to ensure that this is reflected in the price series after splicing. The techniques for doing this are described in paragraphs 14.13 and 14.14.

Not sold at same time

14.11. In the second situation, where one product replaces another but the two products have not sold side by side in the market place, it is necessary to identify any quality differences between the old and new products and to estimate the value of these differences. A simple example of this sort of quality change would be the replacement of a 50 litre drum of industrial solvent by a 45 litre drum. In such cases, where the proportionate change in quantity is relatively small, it is reasonable to assume that the value of the change is directly proportional to the change in quantity; that is, the price of the 45 litre drum can be made comparable with the previous price for the 50 litre drum by applying a factor 50/45. Thus a price relative for industrial solvent would be calculated as follows:


Period 1
Period 2
Period 3

Price of:
50 litre drum
$40
45 litre drum
$40
$42

Price relative for solvent
100.0


= 111.1
= 116.7


In cases where the proportionate change in the unit of quantity is large, this technique cannot reasonably be used. For example, the unit price of a kilogram of cement when purchased in a 25 kilogram bag could not be directly compared with the unit price of a kilogram of cement when purchased as part of a truck load. The two products are different in the sense that they would usually sell in different markets and to different kinds of users. In these circumstances the other techniques for assessing quality change have to be applied, e.g. overlapping prices.

Change in composition

14.12. In the third situation, where there are changes in the composition of a product, the technique used is to identify the quality differences and place a value on them. Frequently the composition of a particular commodity changes as a result of the use of different materials, or the addition or deletion of particular features. An example would be a change in the wool/synthetic mix of a yarn. In such cases, the technique used to estimate the value to the user of the quality change involves ascertaining the additional cost (or saving) to the manufacturer and examining the prices of broadly comparable items (e.g. yarns containing various proportions of pure wool and synthetic fibres).

14.13. Sometimes the modified product differs markedly from the previously priced product - as occurs with a change in models for a particular make of motor vehicle. This type of quality change requires the collection of a considerable amount of information and, in some cases, subjective judgement is required to estimate a monetary value by which to adjust the price. The first step is to obtain a full picture of the differences between the old and new models. This is done by:

      • obtaining detailed information from the manufacturer, such as design and engineering reports;
      • examining published tests and other comments on the new model in trade publications, motoring magazines, etc.; and
      • physically examining the new model and questioning motor dealers about the nature of the changes.

Having identified the precise differences between the models, the next step is to determine which of these differences represent changes in quality and to estimate the monetary value of each change. Some changes are relatively simple to quantify, such as changing the type of tyres on the new model when both types of tyres are sold separately in the market - the value of the quality change can be assessed as the difference in the selling prices of the tyres. Other changes require more detailed examination; for example, if a new model car has cloth covered seats while the old model has vinyl covered seats, the factors that would be considered are:
      • the unit cost to the manufacturer of the change;
      • whether the cloth covered seats have been previously available as an option; if so, what was the price and did a significant number of buyers purchase the option at that time; and
      • the change in comfort and durability of the seats.

14.14. While there is some subjectivity involved in making a final assessment of the dollar value of the changes in a product, it is believed that the quality adjustment procedures result in no significant long-term bias in the price series. The alternative of ignoring quality changes altogether could result in much more significant biases in the price measures. For example, in the case of motor cars, if quality changes had been ignored, we would probably be treating the basic version of the Holden Commodore as an equivalent product to the original 1948 Holden; that is, the whole difference in price between the two would be treated as pure price change.





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