Thread by @captgouda24

Much of economic growth comes not in the form of falling prices, per se, but from the introduction of new goods. Not including them will lead to us substantially understating welfare, and overstating inflation. But how do find the value of goods which didn’t exist? 1/

We can calculate it by figuring out the price of a good which would set demand to 0, and then presume that this shadow price fell when it came into being. To know this, we must estimate the demand curve.

Hausman has data over a few years in 7 major metropolitan areas. His identification of the demand curve stems from local advertising campaigns, which he assumes shifts demand in that city but not elsewhere. The unobserved parts of demand are filled in by assuming convexity.

But there are a few complications. First, brands of cereal are substitutable for each other. Not including this overstates gains to the consumer. On the other hand, simply assuming a constant elasticity of substitution will overstate the gains badly.

In the case of CES demand, every good increases welfare by the same increment, which is obviously inaccurate. So he segments into different types of cereal, and while allowing for cross section elasticities, ignores brand to section elasticities.

Further, we need to take into account the ways that a brand affects other brands by the same company. It might take business away, but on the other hand, it also means that the customers who remain have more inelastic demand.

Put concretely, when GM introduces Apple Cinnamon Cheerios, the people who are still buying Honey Nut Cheerios are the ones who really like it. Thus, GM can charge a higher price.

Hausman estimates that the benefits to the consumer are larger than the losses from price discrimination. Apple Cinnamon Cheerios increased welfare by $78 million a year, and the consumer price index overstated inflation by at least 20% in ready-to-eat cereals.

Jerry Hausman, “The Valuation of New Goods under Perfect and Imperfect Competition” (1996)

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