Intermediate Microeconomics and Its Application 12th Edition by Walter Nicholson,Christopher Snyder

Exercise 6

Valuing New Goods
Estimating how consumers value a new good poses problems both for the firms that might wish to sell the good and for the government agencies that have to assess the impact of such goods on overall welfare. One way that has been used for this purpose is illustrated in Figure 1. In the figure, the typical person's demand curve for a newly introduced good is given by d. After introduction of the product, this typical person consumes X* at a price of P* X. This is the only point observed on the demand curve for this product because the good did not exist previously. However, some authors have proposed using the information in Figure 1 to draw a tangent to d at this initial point and thereby calculate the "virtual price" at which demand for this good would have been zero This price is then taken to be the price before the new good was marketed. The welfare gain from introducing the new good is given by the consumer surplus triangle This is an approximation to the gain that consumers experience by being able to consume the new good at its current market price relative to a situation where the good did not exist. In some cases, the size of this gain can be quite large.
The Value of Cell Phones
Jerry Hausman used this approach in an influential series of papers to estimate the value of cell phones to consumers. He found very large gains indeed, amounting to perhaps as much as $50 billion. Apparently, people really value the freedom of communication that cell phones provide. A major advantage of Hausman's work was to reiterate the notion that the standard methods used to calculate the Consumer Price Index (see Application 3.2: The Consumer Price Index and Its Biases) significantly understate the welfare gains consumers experience from new products. In the case of cell phones, for example, these goods did not enter the CPI until 15 years after they were introduced in the United States. Once cell phones were considered part of the CPI "market basket," no explicit account was taken of the benefits they provided to consumers relative to prior versions of mobile phones.
High-Speed Internet
Although some limited Internet connections were available in the 1980s, it was not until the advent of web browsers in 1993 that the demand for high-speed services began to grow rapidly. Prior to this time most Internet access was through dial-up modems that offered quite limited access. The advent of broadband and the experiences it provided ushered in an entirely new and different product. Internet access fees were first introduced into the Consumer Price Index in 1997. Subsequent research2 developed better way to control for the quality of this service (speed, reliability, and so forth). Results of this research show that consumers have benefited significantly from a decline in the effective price of broadband services, though the degree of price decline seems to have slowed in recent years.
The size of the welfare gain triangle in Figure 1 would seem to depend on the slope of the demand curve at point E. Can you provide an intuitive reason for this? (See also the discussion of price elasticity later in this chapter.)