---
# System prepended metadata

title: 8.31 Econ134 Lec
tags: [ECON 134]

---

### Evolution of thought

* the ideas developed in recent decades
* Boskin commission in 1996
    * landmark event for US price measurement:
    * Concluded CPI converstated inflation primarily due to:
        * Various forms of substitution bias (including outlet substitution)
        * New goods bias/quality change


* Laspeyres index (initial prices as weights):
$$ \frac{p_{a1}q_{a2} + p_{e1}q_{e2}}{p_{a1}q_{a1} + p_{e1}q_{e1}}
$$
* Paasche index (final prices as weights):

$$ \frac{p_{a2}q_{a2} + p_{e2}q_{e2}}{p_{a2}q_{a1} + p_{e2}q_{e1}}
$$



### New Goods & Quality Change
* How should we deal with new goods?
    * No comparison possible with earlier period since good didn’t exist and so no old price/quantity exist
    * Prices of most goods not measured until well after they come into existence (often steep fall to begin with)



#### Case Study : Light
* Progression from open fires to candles to incandescent light blubs to compact fluorescent bukbs and LED lights
* HOW to measure "price" and "quantity" of light?





|  | Incandescent | Fluorescent |
| -------- | -------- | -------- |
| P_1     | $10     | --     |
| P_2     | $12     | $24     |
| P_3     | --     | $18     |

Solution: 
$$
\frac{P_3}{P_1} = \frac{P_{2, old}}{P_{1, old}} \times \frac{P_{3, new}}{P_{2, new}} = \frac{12}{10} \times \frac{18}{24}
$$

|  | Incandescent | Fluorescent |
| -------- | -------- | -------- |
| P_1     | $10     | --     |
| P_2     | $12     | $2.4     |
| P_3     | --     | $1.8     |


### Hedonics
Basic Idea: Directly adjust for quality change between new and old good
• E.g. Nordhaus’ approach of analyzing prices in “per lumen” terms is a hedonic adjustment
• Challenging: Must define which characteristics are important to consumers (and how much they matter)
• e.g. what to include in comparing iPhone 8 and iPhone 14?
• What about Apple iPhone vs old Nokia cell?
• Much more model-dependent (and less transparent) than standard price index formulas
• Also very labor-intensive to specify and estimate hedonic models
• As a consequence, the CPI (and other national inflation statistics) mostly “link in” new goods
• Use hedonics sparingly in some product categories


### East vs West Germany in 1989

* pre-1989 estimates: East German GDP per person 75-85% of West German
* post-1989: East German GDP clearly much smaller relative to West Germany than originally thought

What explains this?


### International Comparisons
* PPP
    * Summers and Heston invented
    * Taken over by World Bank 
* Market comparisons
    * Convert each ountry's GDP into US$$
* PPP adjusted GDP imply most developing countries have ***larger*** economies than standard conomies than standard market-based measures suggest.


### This Class: 
**Making sense of macro events, e.g.,**
* What caused the Great Depression?
* What happened during the Great Recession?

**What is the effect of macro policy?**
* What is the effect of increasing the money supply?
* What is the effect of higher government spending?

**What role for macro policy?**


### Two Approaches:
1. Structural Approach
    * Build an complex Dynamic Stochastic General Quilibrium (DSGE) model of the economy
    * Pros: Can tell you quantitatively
        * The causal effect of B on A
        * the different causes of (say) the Great Depression
        * what macro policy should have done
    * Cons: Economy very complex and model may be wrong (risk of mis-specification)

2. “Reduced-form” approach
    a) Small model to isolate mechanisms and formulate hypotheses, e.g., IS/LM model
    b) Careful empirical study to tease out cause and effects
    * Pros: Transparent, more robust to model mis-specification
    * Cons: Lacks encompassing framework and may give incomplete answers



Difference in group = Average casual effect + selection bias

### OVB
* "selection bias" also called "OVB"
* Get the rid of selection bias
    * Randomized trial









