Employing a fixed-weight index like the Consumer Price Index to adjust a person's salary in response to inflation will overcompensate this person because doing so will allow this person to
A) buy the same bundle of goods as he did before the inflation.
B) achieve a higher level of utility than he did before the inflation.
C) achieve the same level of utility as before the inflation.
D) buy more of all goods.

Question

Quizplus · Accepted Answer

A fixed-weight index like the Consumer Price Index (CPI) measures the cost to purchase a fixed basket of goods over time. When salaries are adjusted based on CPI to counteract inflation, individuals might be overcompensated because they can substitute cheaper goods for more expensive ones, thus potentially achieving a higher level of utility than before inflation. This substitution effect is not accounted for in a fixed-weight index, leading to overcompensation.

Employing a Fixed-Weight Index Like the Consumer Price Index to Adjust