Author Question: List and discuss various types of goods and services omitted from measured GDP. What will be an ... (Read 62 times)

kfurse · **on:** Jun 29, 2018

List and discuss various types of goods and services omitted from measured GDP.

What will be an ideal response?

Question 2

What is the commodity substitution bias? What effect does it have on the CPI?

What will be an ideal response?

aidanmbrowne · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

Household production, such as preparing meals and taking care of children, includes productive activities but does not involve market transactions. Therefore, household production is omitted as part of GDP. Underground production, such as working for cash to avoid taxes or engaging in illegal activities, is not reported to the government and hence is not counted as part of GDP. Leisure time and preserving and improving the natural environment are not production per se but are clearly economic goods. They are not counted as part of GDP because it is hard to quantify and put a monetary value on them.

Answer to Question 2

The commodity substitution bias refers to the fact that people switch (substitute) away from goods and services that have risen in price and buy more goods and services that have not risen as much in price. Thus if the price of Coke rises 20 percent while Pepsi's price does not change, many people will substitute Pepsi for Coke. The commodity substitution bias in the CPI occurs because the CPI uses a fixed market basket of goods and services. So, if the market basket contains, say, 10 bottles of Coke and 8 bottles of Pepsi, the market basket will not change even though people change their buying patterns in favor of Pepsi and away from Coke. The change in people's buying patterns offsets, at least to a degree, the effect of higher prices. In the Coke/Pepsi case, by purchasing more Pepsi and less Coke, people have insulated themselves from part of the effect of the higher price of Coke. However the CPI does not take this change into account and so the CPI reflects the full effect of the higher price of Coke, thereby overstating the actual inflation that people experience.