Question+15+(Daniel)



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A bit too fast..? haha. So, here.  1) Cover. 2) Question. 3) First of all, we should all know that Consumer Price Index cannot be trusted. Well, that is, CPI is not a perfect measure of the cost of living, so it has several drawbacks. There are three problems using CPI: substitution bias, introduction of new goods, and unmeasured quality change. Now, with this in mind, let’s look at this phrase in the question. 4) “price ... rises” Whenever there is an increase in prices, or inflation, “substitution bias” can become a problem. What is substitution bias? 5) Let’s say there was Apple and Windows in the market. When it was 4 dollars for both, they attracted the same number of costumers. 6) However, when there was inflation in the market and only Windows price inflated, some of the costumers shifted to Apple. But when computing CPI, the Bureau of Labor Statistics uses a fixed basket, which assumes that costumers continue buying the expensive Windows in the same quantities as before. So CPI would be greater than the actual cost of living. 7) The fact that “CPI rises from 150 to 175” becomes 8) irrelevant. 9) Initially, milk was $1 and T-shirt was $8. 10) Then, milk became $1.25 and T-shirt $10. 11) If we solely look at the inflation rate of each products, we find that both have the same inflation rate, 25%. 12) Thus, neither will become relatively less expensive, and both products will experience lower consumption.