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The price of quality

| Posted by: Paul Donovan | Tags: Paul Donovan Weekly

  • March US consumer price inflation data showed a collapse in the price of "wireless telephone services" – the price of using a phone. Prices declined 7%, dragging down overall inflation.
  • However, the price of using a phone may not have declined at all. Consumer price inflation changes if product quality changes. If product quality improves but the price stays the same, consumers are assumed to be getting more for their money; consumer price inflation will record a price decline. Last month a US wireless telephone provider increased the data that their customers could download. Assuming that the ability to download unlimited YouTube videos of performing cats is a quality improvement, the US deemed an unchanged price to be a declining price.
  • This matters to investors. If a consumer price is falling because of quality improvements, it does not mean that consumers have more money to spend on other goods. It also says very little about general trends in corporate pricing power. A quality-induced price fall has different economic consequences from a genuine price fall.
  • Quality adjustment will also raise the price of something if the quality is worse. US consumer price inflation adjusts the price of airfares for quality. Whether the experience of flying a US airline has been improving or deteriorating is a judgment best left to the official statisticians.