New Goods and Index Numbers: U.S. Import Prices
Researchers constructing index number frequently face the problem of new (or disappearing) goods, for which the price and quantity are not available in some periods. In theory, the correct way to handle a new good is to treat its price before it appears as equal to the reservation price (i.e., where demand is zero); in practice, this method can be difficult to implement. However, if the underlying aggregator function is CES then the reservation price is infinity, and we show that the corresponding price index takes on a very sensible form. We apply this formula to measure the price index for six disaggregate U.S. imports, which have been supplied from many new countries over the past several decades. We find that by incorporating the new supplying countries, the price index for developing countries is significantly lower than would otherwise be measured.
Published: revised as "New Product Varieties and the Measurement of International Prices", American Economic Review, Vol. 84, no. 1, pp. 157-177, (March 1994).