Product Turnover and the Cost of Living Index: Quality vs. Fashion Effects

Abstract

This paper evaluates the effects of product turnover on a welfare-based cost-of-living index. We first present some facts about price and quantity changes over the product cycle employing scanner data for Japan for the years 1988-2013, which cover the deflationary period that started in the mid-1990s. We then develop a new methodology to decompose price changes at the time of product turnover into those due to the quality effect and those due to the fashion effect (i.e., the higher demand for products that are new). Our main findings are as follows: (1) the price and quantity of a new product tend to be higher than those of its predecessor at its exit from the market, implying that firms use new products as an opportunity to take back the price decline that occurred during the life of its predecessor under deflation; (2) a considerable fashion effect exists for the entire sample period, while the quality effect is declining over time; and (3) the discrepancy between the cost-of-living index estimated based on our methodology and the price index constructed only from a matched sample is not large.