Suppose prices of personal computers fall significantly and consumers respond by buying more personal computers.The consumer price index
A)reflects this price decrease accurately.
B)understates this price decrease due to the substitution bias.
C)overstates this price decrease due to the income bias.
D)overstates this price decrease due to the substitution bias.

Question

Quizplus · Accepted Answer

The consumer price index may not accurately reflect the price decrease due to substitution bias. The index uses a fixed basket of goods and services, and if the price of one item (in this case, personal computers) falls significantly, consumers tend to substitute this item for others that are relatively more expensive in the fixed basket. As a result, the index may overestimate the actual inflation rate and understate the price decrease.

Suppose Prices of Personal Computers Fall Significantly and Consumers Respond