mance in markets with few suppliers,
as in broadband. Yet, a policymaker
cannot address questions about pricing without understanding whether
the CPI measures prices accurately.
measuring technical improvement
As it does elsewhere, BLS uses very
cautious procedures for recording
benefits from upgrading to broadband. There is a rationale behind
that caution: Not all users experience the benefits of broadband in
the same way. For example, capacity/
bandwidth differs between households and the location in the national grid matters. Accordingly, rather
than merely assuming households
benefit from the availability of a new
service, such as broadband, the BLS
waits for clear evidence that buyers
like the improvements.
This approach leads to what is
sometimes called a “transactional” index. Standard procedures do not measure technical progress at the frontier
unless users transact for a better good
or service. Moreover, the CPI focuses
on the average experience, getting an
average price by taking a weighted average over all transactions, including
those not at the frontier.
That is why, for example, wireless
broadband tended not to play a big role
in the official price index until after
2006. Wireless broadband revenue was
small in comparison to the revenue for
wireline broadband. Incidentally, that
is also why McDevitt and I focused our
study on wireline broadband, the bulk
of transactions for which there is public data up until 2006.
The CPI for Internet access is officially called Internet services and electronic information providers, and the
internet hh ( 1)
broadband hh ( 1)
official index ( 2)
Corrected index ( 3)
( 1) millions of u.s. households.
( 2) Quote from december of each year.
BLS began compiling data in December 1997. BLS deserves some credit
for starting this index not long after
the diffusion of the Internet began.
At that point approximately 20% of
U.S. households had adopted dial-up
commercial Internet service, and less
than 1% had adopted broadband. The
second and third rows of the table illustrate this point.
In the fourth row is a monthly quote
from the official price index, taken
from December of each year, and normalized to 100 for the year in which
the index began. It indicates that the
CPI for Internet access in the U.S. went
mildly down and up and down for
eight years. Then, in late 2006, it broke
with all prior patterns and declined
more than 18% from its base (i.e., ( 94. 5
– 77. 2)/94.2 = 0.183). That drop continued and settled at a 23% from its base
in January 2007 (i.e., ( 94. 5 – 73. 4)/94.5),
staying near that level ever since.
Did that last drop reflect increasing
competitiveness of broadband markets? In fact, it does not. The dramatic
drop in the official price index for the
U.S. primarily reflects the pricing of
the declining good, dial-up service.
An informed reading of the business
news explains why. The largest U.S. dial-up provider, America Online (AOL),
altered its pricing policies in the fall
of 2006. AOL announced it was moving to advertising-supported service.
On top of that, BLS used its standard
cautious procedures. That gave AOL’s
prices close to a quarter of the weight
in the index (even though AOL’s market share was dropping).
Diffusion and Prices
The official index is less informative
about broadband prices for an addi-
tional but rather subtle reason. Standard price index survey procedures
measure the price at which the new
good transacted but not at the price
that previously deterred the user from
adoption. For example, in many neighborhoods broadband was not available
in any form for some time until after
2000. Even when it became available,
it may not have been reliable enough
(initially) to spur many households
to switch immediately from dial-up.
These users waited until vendors improved the infrastructure or service
arm of the organization. In short, users
did not adopt until quality improved.
That common occurrence creates a
problem for BLS. Household eventually converted from dial-up to broadband, as rows 2 and 3 of the table
indicate. However, there was (
seemingly) no measured price change or
qualitative improvement affiliated
with the upgrade.
What would have happened to the
broadband price index if it reflected
unmeasured qualitative improvement?
That is a succinct way to understand
one aim of our study. McDevitt and I
followed the standard recommendation for this problem. It goes back to
work by Sir John Hicks, a Nobel Prize
Laureate in Economics, and has been
used many times in economic analysis. The price index should employ
what a user would have been willing to
expend to get the new service before it
Many surveys tell us what that willingness was. Even the most cautious
surveys from the time period suggest
the average convert was willing to pay
approximately $51.35 per month (on
average), but actually had to pay less. If
the actual price was $36, for example,
( 3) Applies estimates from “the broadband bonus: Accounting
for broadband internet’s impact on u.s. GdP”, table 7, row 2.