Question

Which of the following can cause the Consumer Price Index to incorrectly calculate the cost of living?

	Consumers substitute away from goods with prices that are rising relatively quickly.
	The index does not immediately incorporate new goods into its basket.
	The index generally does not account for changes in the quality of goods.
	The appearance of discount stores is not immediately incorporated in the index.
	All the above

Answer 1

Option E.

• CPI measures the average prices of all the goods and services in a fixed market basket that is purchased by a consumer.
• It incorrectly calculates the cost of living due to various biases.
• These biases include :-

1. Substitution bias - when price's increase, people substitute higher priced products with lower priced products. This is not reflected by the CPI.
2. New product bias - It does not immediately incorporate new products into the basket as it is fixed.
3. Quality bias - it does not account for the changes in quality of a good.
4. Outlet bias - The appearence of discount stores are not incorporated in the index.