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Unformatted text preview: Problems with the CPI While the CPI is a convenient way to compute the cost of living and the relative price level across time, because it is based on a fixed basket of goods, it does not provide a completely accurate estimate of the cost of living. Three problems with the CPI deserve mention: the substitution bias, the introduction of new items, and quality changes. Let's examine each of these in detail. Substitution Bias The first problem with the CPI is the substitution bias. As the prices of goods and services change from one year to the next, they do not all change by the same amount. The number of specific items that consumers purchase changes depending upon the relative prices of items in the fixed basket. But since the basket is fixed, the CPI does not reflect consumer's preference for items that increase in price little from one year to...
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This note was uploaded on 12/13/2011 for the course ECO 1310 taught by Professor Staff during the Fall '10 term at Texas State.
- Fall '10