Price Indexes (7) Overlap Pricing

The most common solution to the problem described in the previous post is to make the change before the old product disappears. Then the old product and new products can be surveyed in a cross-over period. A price relative for the old product is used to calculate the price movement up to the crossover period. A price relative for the new product is used to measure the price movement going on from the crossover period. This ensures that the matched sample used to calculate the price change between any two periods actually matches. This method is called Overlap Pricing.

This is where quality adjustment comes. A noted, the old and new products will quite likely be of different quality. The Overlap Pricing method assumes that because the two products are selling in the same market at the same time, the difference in price between the two products reflects the difference in value to consumers between the two products. If this were not true one, one of the products would stop being sold.

The Overlap Pricing method is the preferred method where the sample of prices has to be changed because the market decides the value of the difference between the old and new item.

There are some situations where the Overlap Pricing method is impractical. Sometimes when a new model is introduced to the market the old model is completely sold out before the new one is introduced. Or if the old one is still available, it might be so unpopular that it has to be massively discounted to clear the old stock. This is generally the situation with cars, stereos televisions and computers.

Statisticians cannot assume that the difference between the two products is reflected in their price difference, so they have no choice but to make a judgment about how much of the difference in price is the result of differences in quality and how much is genuine price change. This method is called Direct Adjustment.