The Consumer Price Index attempts to measure the cost of achieving a certain mat

Question

The Consumer Price Index attempts to measure the cost of achieving a certain material standard of living (think, "utility"). In order to do this, it computes the cost of buying a fixed basket of goods each month. Use income and substitution effects to show that, to the extent that goods are (imperfect) subtitutes, the CPI will overstate the increase in the true cost of living. Hint: show that the original utility can be obtained at the new prices by spending less money than is necessary to purchase the old optimal bundle.

Explanation / Answer

The Consumer Price Index attempts to measure the cost of achieving a certain mat

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