Is the CPI a biased measure of the inflation rate? Explain your ...

[Kthamas]

Is the CPI a biased measure of the inflation rate? Explain your answer.
 
  What will be an ideal response?

Question 2

Using the above figure, during which of the following periods does the price of crude oil have a downward trend?
 
  A) May to July
  B) May to November
  C) July to October
  D) October to December

[alexisweber49]

Answer to Question 1

There are at least four sources of bias in the CPI measure. The first bias is the new goods bias, which refers to the fact that new goods are continuously replacing old ones. Because the new goods are often both of higher quality and higher priced, their introduction complicates measuring the CPI. The new goods bias biases the CPI upwards. Second, the CPI is not always adjusted for improvements in the quality of the products, which is the quality change bias. A price hike that reflects a quality increase often is mistakenly recorded as only a price hike, with no recognition given to the higher quality. Third, consumers substitute relatively lower priced goods for goods that increase in price, which is called commodity substitution. However, the CPI doesn't take this substitution into account, thereby giving rise to the commodity substitution bias. Fourth, when faced with price hikes, consumers switch away from buying at full service stores to buying from discount stores because the prices in the discount stores are lower. Once again, the CPI does not take account of this outlet substitution and so the CPI suffers from the outlet substitution bias.

Answer to Question 2

C