Question

The traditional Consumer Price Index (CPI) differs from the Chained-CPI
because it doesn’t consider that people may substitute similar goods when one thing gets too expensive.

True

False

Answer 1

True

The traditional CPI method is based on spending patterns in the past. It does not incorporate the effects of consumers’ substitution when their relative prices change. Hence this method overstates the amount of decline in consumer well being due to increase in prices. The chained CPI method takes into account the fact that when prices of goods increase, consumers substitute the same for cheaper goods. Hence it results in a lower amount of decline in consumer well being due to inflation.