This note provides an elementary introduction to the measurement of welfare gains from the introduction of a new good, based on the concept of the ‘virtual price’ and standard expressions for welfare changes arising from price changes.
Any attempt to measure changes in living standards using an income or consumption based welfare metric faces a limitation arising from the fact that it cannot deal with the introduction of new commodities. The role of new commodities over, say, a ten year period can be substantial. Furthermore, significant quality improvements can be regarded as involving an essentially new commodity. An individual with an unchanged total expenditure over a period may be better off as a result of innovations resulting in new goods.
This paper provides an elementary introduction to a method of allowing for new goods which makes use of standard measures of welfare change that are usually used in the context of price changes (and, in particular, price changes arising from indirect taxes). There is now a substantial and often technical literature so the aim here is merely to clarify, and illustrate with a simple example, one approach to the analysis of the welfare gains arising from new goods.