The substitution by consumers of one good for another because of relative price changes is: A. the CPI and causes the CPI to overestimate the cost-of-living changes. B. captured by the CPI and causes the CPI to underestimate the cost-of-living changes. C. not captured by the CPI and causes the CPI to overestimate the cost-of-living changes. D. not captured by the CPI and causes the CPI to underestimate the cost-of-living changes.

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Esther Brennan

20 December, 12:54

The substitution by consumers of one good for another because of relative price changes is: A. the CPI and causes the CPI to overestimate the cost-of-living changes. B. captured by the CPI and causes the CPI to underestimate the cost-of-living changes. C. not captured by the CPI and causes the CPI to overestimate the cost-of-living changes. D. not captured by the CPI and causes the CPI to underestimate the cost-of-living changes.

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Olive Avila · Answer 1

C) not captured by the CPI and causes the CPI to overestimate the cost-of-living changes.

Explanation:

The two main problems with the CPI as a measure of inflation is that:

it doesn't account for the substitution of products, resulting in an overestimation of the living costs. e. g. households decide to buy more chicken than beef because its cheaper, but the relative weight of beef in the CPI doesn't change. it includes imported goods while the GDP excludes them. e. g. even though the US is the largest producer of oil in the world it still imports oil and uses it to produce gasoline which is included in the CPI, but not the GDP.