agent also obtains a technical description of the substitute article to ensure that future prices will be quoted on the same quality and quantity. When there are problems of quality change, linking is employed. Linking is the method of "splicing" a price based on a new or different quality to the preceding one at the same point in time as a means of factoring out the difference in price. The pricing procedure in effect since the 1964 revision has broadened the representation of retail outlets and more accurately reflects improvements in the quality of the items measured.

The handling of quality changes has always posed problems for those concerned with computing price indexes.' This is particularly true with respect to prices for medical care and services where quality changes are especially difficult to measure because of advances in medical technology.R

A 1961 report prepared by the National Bureau of Economic Research for the Bureau of the Budget focused on the issue of measurement of quality changes in the CPI, with specific references to the medical care component. This issue was also discussed at length in 1961 congressional hearings before the Joint Economic Committee.10 It was held, in general, that the index failed to take account of quality changes, such as the steady advance of medical knowledge, and that this failure introduces a systematic upward bias. This idea was based on the assumption that prices are compared directly and that, when the quality of goods deteriorates, the index tends to understate the true price rise and, when quality improves, the index tends to overstate the true rise in prices. The opposite situation may prevail, however, when prices are linked. Linking treats the entire difference in prices as a quality difference, though

7 See Milton Gilbert, "The Problem of Quality Changes and Index Numbers," Monthly Labor Review, September 1961; and Ethel D. Hoover, "The CPI and Problems of Quality Change," Monthly Labor Review, November 1961. 8 See Herbert E. Klarman, The Economics of Health, Columbia University Press, 1965, pages 149-162; and American Medical Association, Report of the Commission on the Cost of Medical Care, 1964, pages 50-51.

9 George J. Stigler, The Price Statistics of the Federal Government, National Bureau of Economic Research, New York, 1961.

10 U.S. Congress, Joint Economic Committee, Subcommittee on Economic Statistics, Hearings: Government Price Statistics (87th Congress, First Session), May 1961.

part of it may be a real price change. This price change is not reflected in the index. The net bias in the index depends to a great extent upon the degree to which linking is used.

The Subcommittee urged more prompt introduction of new products-a matter of particular importance in the case of drugs and prescriptions. Coverage of the latter was greatly improved by the 1964 revision. Moreover, the revised method of grouping all consumer goods and services into 52 expenditure classes as a basis for sampling items to be priced makes it feasible to add or substitute items as changes are deemed appropriate.

The Subcommittee also suggested an adjustment for quality improvement in hospital services by taking account of the length of hospital stay required for a particular surgical procedure or for recovery from a particular illness. It was hypothesized that the new drugs and diagnostic techniques might reduce length of hospital stay or that the number of physician visits normally associated with a particular illness and greater "value" per visit might thus result. Using this approach one researcher has developed in detail an alternative method of measuring medical costs by pricing the total illness rather than the individual items and services.11

Such an approach has been frequently recommended as a method of arriving at a more accurate index of medical care costs, since over the long run the conventional medical care index may have overstated the real price increase for the reasons already discussed. The results of this study show, however, that in the period from 1951-52 to 1964-65 the costs of treatment of the five conditions covered (acute appendicitis, maternity care, otitis media in children, fracture of the forearm in children, and cancer of the breast) increased at a higher rate than the BLS medical care price index. The difference is due to some extent to the fact that the "total illness approach" takes account of a number of factors affecting costs not taken into account by the BLS, including the introduction of more complicated and

11 Anne A. Scitovsky, "An Index of the Cost of Medical Care A Proposed New Approach," in The Economics of Health and Medical Care (Proceedings of the Conference on the Economics of Health and Medical Care), 1964, pages 128-43; and Anne A. Scitovsky, Changes in the Costs of Treatment of Selected Illnesses, 1951-1965 (paper presented at the annual meeting of the American Public Health Association, San Francisco, in 1966).

costly types of treatment. The study concluded that additional research in this field is needed.

GENERAL TRENDS, 1946-66

Since World War II, the CPI and its medical care component have been continuously rising, with the latter rapidly outpacing the former (chart 1). The year 1946 was chosen as the base year because it was the first full year following the lifting of price controls after World War II. From 1946 to 1966, medical care prices increased at a rate more than half again as fast as that

for consumer prices-110 percent compared with 66 percent. The medical care price index is made up of services, except for drugs and prescriptions. In general, the cost of services has risen faster than that of commodities, but the prices of medical care services have risen even more rapidly than the prices of other services. During the past two decades, the medical care service component of the CPI increased 129 percent while the index for all services rose 95 percent.

The Report to the President on Medical Care Prices indicated that the long-run upward trend in medical care prices is related to the economic forces of demand and supply of medical services.

TABLE 1.-Consumer price index and average percentage changes for selected medical care components, by selected years, 1946-66

[1957-59-100 unless otherwise specified]

CHART 2.-Average annual percentage increase in the consumer price index, all services and medical care services for selected periods

66

5.4

charges..

37.0 112.7 153.3 168.0

8.3

6.3

9.6

Physicians' fees..

Drugs and prescriptions 1.

Index base for prescriptions, March 1960; for over-the-counter items, December 1963.

Source: Consumer Price Inder, Bureau of Labor Statistics.

Since World War II, for example, the demand for physicians' services increased more rapidly than did the supply of physicians. As a result, physicians raised their fees and their productivity. Factors contributing to the rapid increases in demand for physicians' services include increasing population, rising personal income, expansion of insurance coverage and increasing public awareness of the curative powers of physicians. Long-run increases in the cost of hospital care, according to the Report, reflect the partial catching up with wages of hospital employees which had been low in relation to those in other sectors of the economy-as well as the growing complexity of the hospital plant and rapid increases in specialized care facilities that are available in hospitals.

The average annual increase in the CPI as a whole amounted to 3.0 percent for the period 1946-60. There was a perceptible slowing down in the rate of increase for all consumer prices during 1960-65, when the CPI rose at a rate of about two-fifths that for 1946-60 (1.3 percent compared with 3.0 percent). The trend in prices of all services followed a similar pattern (table 1 and chart 2). But the slowdown in the rate of increase during 1960-65 for all medical care services was not as appreciable, representing about two-thirds of the annual rate of increase for the period 1946-60.

The general deceleration in price increases that took place between 1960 and 1965 came to an abrupt halt in 1966. The CPI for 1966 was 113.1

Consumer

Price Index

All Services

Medical Care Services

Source: Consumer Price Index, Bureau of Labor Statistics.

or 2.9 percent higher than the index for the previous year and more than double the annual rate of increase from 1960 to 1965. Medical care prices also rose in 1966 at nearly twice the annual rate for the earlier period. The index for all services was also substantially higher during 1966, and reported increases in medical care services were even greater.

Clearly, a general acceleration of consumer price increases, particularly for medical care, occurred during 1966. To obtain a more precise picture of the short-run increases in prices, an examination is made here of quarterly, semiannual, and year-end figures. Year-end medical care price indexes and yearly percentage changes for the 3 years 1964-66 are shown in table 2; 6-month changes are reported in table 3; and table 4 shows the quarterly figures, including indexes for the first quarter of 1967.

A general acceleration of all consumer price rises started in the last quarter of 1965 and continued during each of the first 3 quarters of 1966. In the final quarter of 1966 and the first quarter of 1967, however, the rate of increase subsided. somewhat, from a 1.1 percent increase during the third quarter of 1966 to an increase of 0.3 percent for the first quarter of 1967.

Quarterly figures for medical care service prices show a different pattern. A more rapid pace in these price rises began in the first quarter of 1966, continued in the second quarter, and intensified in the succeeding 3 quarters. From December 1965 to December 1966, they increased 8.1 percent (chart 3). About three-fifths of this increase took place during the second half of the year. The advance in the third quarter of 1966 alone was 4 times greater than that for the corresponding period in 1965. During the first quarter of 1967, these prices rose 2.5 percent, the highest quarterly increase that had been reported for these services for many years.

HOSPITAL CHARGES AND COSTS

Hospital Service Charges

The BLS does not compute a summary index for hospital service charges. Three separate hospital service items are measured for the CPI: (1) hospital daily service charge (room rate); (2) operating room charges; and (3) X-ray diagnostic services for upper gastrointestinal (G. I.) series.

As defined for the CPI, the hospital daily serv

It

ice charge is the amount charged to adult inpatients for routine nursing care, room, board, and minor medical and surgical supplies. usually excludes such additional charges incorporated in the hospital bill as those for laboratory work, X-rays, operating room, and special nursing. Indexes for operating room charges and for the X-ray diagnostic series have been developed only within the past 3 years.

These three sets of indexes do not represent all the charges for services provided in the hospital. Drugs, intensive-care units, and laboratory serv