Other stories in this month's Digest How Fast Are Semiconductor Prices Falling? Microprocessor unit (MPU) prices are declining faster than the Producer Price Index suggests, according to research into pricing practices over the last decade. After falling rapidly through the mid-2000s, the price of computer chips has declined very slowly in recent years according to the Producer Price Index (PPI). The slowdown is especially puzzling given the continuing rapid advances in semiconductor technology. In How Fast Are Semiconductor Prices Falling? (NBER Working Paper No. 21074 ), David M. Byrne , Stephen D. Oliner , and Daniel E. Sichel address this puzzle. The researchers focus on microprocessor units (MPUs), which account for about half of the semiconductors produced in the United States, and on pricing by Intel, the largest manufacturer of these chips. They determine that the matched-model procedure used to calculate the PPI for MPUs is not appropriate under the pricing regime that Intel adopted in the mid-2000s. That was when Intel began keeping the list prices of existing chips largely unchanged. Prior to 2003, the price of a particular Intel MPU model tended to drop fairly rapidly in the year or two following its introduction, especially once newer and faster models became available. By 2006, however, the posted price of a specific model tended to remain constant even after faster chips became available. This change in Intel's behavior could account for the disconnect between continuing improvements in MPU performance and the reported slow-down in price declines. While it may work well in many settings, the authors argue that the matched-model methodology that underlies the PPI generated biased estimates in the case of MPUs after the mid-2000s. In particular, when a chip's posted list price declines little if at all over its life cycle, the corresponding matched-model index will fall very slowly even if newly-introduced chips enter the market at greatly reduced, quality-adjusted prices. The authors suggest that hedonic indexes, such as one they develop that incorporates an end-user measure of performance to control for quality changes, provide a more accurate measure of price change since the mid-2000s. Their hedonic index of MPU prices tracks the PPI closely through 2004. However, from 2004 to 2008 their preferred index fell faster than the PPI, and this disparity grew after 2008. Between 2008 and 2013, for example, their preferred index fell at an average annual rate of 43 percent, while the PPI declined at only an 8 percent annual rate. The authors find that quality-adjusted MPU prices continued to fall rapidly after the mid-2000s, contrary to the picture from the PPI. Their results have important implications for understanding the rate of improvements in semiconductors, the pace of overall innovation, and, potentially, the U.S. economy more generally. They conclude that concerns that the semiconductor sector has begun to fade as an engine of growth appear to be unwarranted, and that in fact rapid advances have continued. However, the researchers note, their results raise a new puzzle. In recent years, the price index for computing equipment in the National Income and Product Accounts has fallen quite slowly by historical standards. If MPU prices have in fact continued to decline rapidly, why has this not been reflected in the price of computers? They suggest that the official price indexes for computers may be inaccurate, in part because of the challenge of identifying the relevant and likely changing characteristics that determine quality. The authors suggest that end-user performance measures like the one they develop to study MPUs could also help to improve the estimation of computer price indexes. — Matt Nesvisky The Digest is not copyrighted and may be reproduced freely with appropriate attribution of source.