MCQ5. Assume the price of one good included in the basket used to measure CPI in
ID: 1140839 • Letter: M
Question
MCQ5. Assume the price of one good included in the basket used to measure CPI increases by 50%. Then a. People will stop buying that particular good. b. The cost of living would increase, but the substitution effect means that the CPI will c. The cost of living would increase, but the substitution effect means that the CPI wil d. the cost of living decreases, and the substitution effect means that the CPI will e. The cost of living would decrease and the CPI will exactly estimate the size of the change underestimate the effect on the changes. overestimate the effect on the changes. overestimate the effect of the changes.Explanation / Answer
ANS=OPTION C
The COL will rise, but the substitution impact implies that the CPI will overestimate the impact on the changes
The CPI is a computation of inflation measured by American government statisticians based upon the price level from a fixed basket of commodities which denotes the purchases of the average individual. The ‘ substitution bias ’ causes a rate of inflation computed utilizing a fixed basket of commodities over time to overstate the actual increase in the cost of living as it doesn’t take into consideration that persons can substitute away from products whose prices increase disproportionately.
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