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We measure inflation using the Consumer Price Index (CPI), but the CPI is an imperfect measure...

We measure inflation using the Consumer Price Index (CPI), but the CPI is an imperfect measure of prices because of three problems. Identify those three problems and discuss whether they overstate or understate the level of inflation in the economy. In your discussion, analyze how by deviating from the “typical consumer” that the CPI attempts to track affects the problems in the CPI.

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Answer #1

Dona sees that the size of chocolate has shrunk, while the price has been unchanged. This understates the inflation as people do not always notice the change in size and do not realise that the price has increased in the real terms.

When the old minivan is replaced with newwan, the price rose. The price rose but there were additional features also. So, inflation is overstated. The price rise may have been due to additional features only.

In the case of muffin and bagel, the inflation is overstated here.

The price rose doubled in 15 years. there is no overstatement or understatement of inflation.

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