If consumers purchase fewer of those products that increase most in price and more of those products that increase less in price as compared to the CPI basket, then changes in the CPI ___________. understate the true rate of inflation are smaller than the change in the GDP deflator. reflects the decrease in quality bias overstates the true rate of inflation reflects the increase in quality bias
Question
If consumers purchase fewer of those products that increase most in price and more of those products that increase less in price as compared to the CPI basket, then changes in the CPI ___________.
understate the true rate of inflation
are smaller than the change in the GDP deflator.
reflects the decrease in quality bias
overstates the true rate of inflation
reflects the increase in quality bias
Solution
The correct answer is "overstates the true rate of inflation".
Here's why:
The Consumer Price Index (CPI) measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. If consumers purchase fewer of those products that increase most in price and more of those products that increase less in price as compared to the CPI basket, then they are essentially substituting cheaper goods for more expensive ones.
The CPI, however, assumes a fixed basket of goods and does not account for this substitution effect. As a result, it may overstate the true rate of inflation because it is based on a fixed basket of goods and does not reflect changes in buying habits.
In other words, if consumers are able to maintain their level of satisfaction (utility) by substituting cheaper goods for more expensive ones, then the increase in the cost of living may be less than what is indicated by the CPI. Therefore, changes in the CPI overstate the true rate of inflation.
Similar Questions
The quality change bias is most likely to put ________ into the CPI and so ________ the inflation rate. a. a downward bias; overstate b. a downward bias; understate c. an upward bias; understate d. an upward bias; overstate
If consumers purchase fewer of those products that increase most in price and more of those products that increase less in price as compared to the CPI basket, then changes in the CPI __________
Suppose that the price of chicken rises sharply compared to the price of turkey. In response, consumers buy more turkey and less chicken than they did in the CPI base year. In this situation, the CPI will tend to ___________ inflation as a result of _____________ bias. understate; substitution bias. overstate; lifestyle bias. overstate; outlet bias. understate; increase in quality bias. overstate; substitution bias
The price of bananas has come down while the price of pineapples has gone up. As a result, consumers buy more bananas and less pineapples. When considering these changes in spending behaviour in relation to the CPI basket, changes in the CPI ___________. are less than the true rate of inflation overstate the true rate of inflation actually reflect the true rate of inflation are determined by the Australian Government are proportional to the increase in quality bias
Inflation is aAn average decrease in the price level bA change in relative prices of goods cAn increase in the average price level d
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