Question

Why does the Consumer Price Index often overstate the changes in the (true) cost of living?

Answer 1

CPI is an economic tool used to measure the rate of inflation. It is widely used to measure the urban inflation rate and so is called the consumer's price index. More than often it overstate the changes in the true cost of living. Primarily this happens because it does not account for the substitution people make when they switch to goods that are now relatively less expensive, resulting in commodity substitution bias.

Sometimes consumers search for a lower priced product to save money which is again not captured by CPI and this results in outlet substitution bias. There are new goods bias and quality change bias as well, all of which are helpful in suggesting that CPI does not accommodate these changes in consumption pattern and thus, overstate the changes in the true cost of living?