Question

How do “free” products make the calculation of GDP more difficult? What are hedonic adjustments, and why are they necessary? Will inflation tend to be overstated or understated if quality improvements are not accounted for? Explain

Short answer

The free products make the calculation difficult as it is difficult to calculate the value consumers receive from that particular service or product.

Hedonic adjustments are price adjustments in accordance with the change in product characteristics due to a change in CPI. The hedonic adjustments are important because they reduce inflation.

Inflation tends to be overstated. It doesn’t consider the facts like the ability of the consumer to substitute goods, and it also fails to account for the improvements in the products.

Step-by-step solution

Free products and difficulty in the calculation of GDP

The free products always make the GDP calculation difficult. Every consumer is ready to get free goods and services, and no consumer has an incentive to show their willingness to pay for these goods and services. In such cases, the true value of free products remains unidentified. The value generated by the good or services won’t get reflected in the economic activity, and sometimes it will result in difficulty in deriving exact output.

Hedonic adjustments and the importance

Hedonic adjustments are used to influence consumer behaviour by price adjustments of goods in the economy. They influence consumer behaviour through price adjustments of goods in the economy in relation to the change in the characteristics of these goods.

The hedonic adjustments are important in the market. They are primarily used as a tool to control inflation in the market. The hedonic adjustments also help improve the quality of goods and are mostly used in the UK and USA.

Quality improvements and inflation

Inflation tends to be overstated if the quality improvements are not adjusted. It is because CPI doesn’t consider the facts like the ability of the consumer to purchase a substitute good when the price of one good is increased. Besides, quality improvements are hard to measure in a monetary system, and CPI fails to consider such factors while calculating inflation.

So most of the time, quality improvements are not considered, and inflation tends to be always overstated.