In 2000, you could buy a Cadillac DTS for $45,000. In 2011, the Cadillac DTS sold for $55,000. While both models include anti-lock brakes and air bags (along with other similar features), the 2011 model also includes satellite radio and new technology that provides improved gas mileage and safer driving. If the Cadillac DTS was included in the CPI basket, it would create
A) a downward bias in the inflation rate.
B) an upward bias in the CPI as a result of quality change bias.
C) an upward bias in the CPI as a result of commodity substitution bias.
D) a downward bias in the CPI as a result of new goods bias.

Question

Quizplus · Accepted Answer

The inclusion of the Cadillac DTS, with its added features in the 2011 model, in the CPI basket without adjusting for the quality improvements (like satellite radio, improved gas mileage, and safer driving) would lead to an overestimation of the price increase. This is because the price increase is partly due to these quality improvements, not just inflation. This scenario is known as quality change bias.

In 2000, You Could Buy a Cadillac DTS for $45,000