Suppose that the computation of a price index were to give energy consumption a 20 percent weight over the decade from 1973 through 1982. Suppose further that conservation during that time actually reduced the share of expenditure on energy while the relative price of energy rose. It could be concluded, in this case, that
A) changes in the index would be an accurate measure of the rate of inflation affecting household budgets.
B) changes in the index would overestimate the rate of inflation affecting household budgets.
C) changes in the index would underestimate the rate of inflation affecting household budgets.
D) the index would not change at all.
E) none of the above can be determined from the information provided.

Question

Quizplus · Accepted Answer

If the share of expenditure on energy decreased due to conservation, but the index still gives energy a fixed 20 percent weight, it would not accurately reflect the decreased importance of energy in household budgets. Meanwhile, the relative price of energy rising would contribute to an overestimation of inflation's impact on household budgets, as the index would overemphasize the cost increase in a sector where households are actually spending less.

Suppose That the Computation of a Price Index Were to Give