Sourcing Substitution and Related Price Index Biases

Abstract

We define a class of bias problems that arise when purchasers shift their expenditures among sellers charging different prices for units of precisely defined and interchangeable product items that are nevertheless regarded as different for the purposes of price measurement. For business-to-business transactions, these shifts can cause sourcing substitution bias in the Producer Price Index (PPI) and the Import Price Index (MPI), as well as potentially in the proposed new true Input Price Index (IPI). Similarly, when consumers shift their expenditures for the same products temporally to take advantage of promotional sales or among retailers charging different per unit prices, this can cause a promotions bias problem in the Consumer Price Index (CPI) or a CPI outlet substitution bias. We recommend alternatives to conventional price indexes that make use of unit values over precisely defined and interchangeable product items. We argue that our proposed ideal target indexes could greatly reduce these biases and make use of increasingly available electronic scanner data on prices and quantities. We also address the challenges national statistics agencies must surmount to produce price index measures more like the specified target ones.