Why does the substitution bias cause the consumer price index to overstate inflation and the cost of living? Why does the increase in quality bias cause the consumer price index to overstate inflation and the cost of living?
What will be an ideal response?
The substitution bias causes the CPI to overstate inflation and the cost of living because the CPI, being based on a fixed market basket of goods and services, implicitly assumes that consumers do not switch away from products whose prices are rising and into products whose prices are falling (or rising less). Consumers dodge some price increases by switching to other products, therefore decreasing their cost of living below what the CPI indicates.
The increase in quality bias causes the CPI to overstate inflation and the cost of living because a portion of the price increase of many goods and services is due to an increase in quality. The Bureau of Labor Statistics tries to filter out the portion of the price increase due to quality, but does not fully adjust the price increase for quality improvements.
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Gabrielle, an Italian citizen, uses some previously obtained dollars to purchase a bond issued by a U.S. company. This transaction
a. decreases U.S. net capital outflow. b. does not change U.S. net capital outflow. c. increases U.S. net capital outflow by more than the value of the bond. d. increases U.S. net capital outflow by the value of the bond.
A factual claim about how the world actually works is a ________ statement.
A. positive B. irrational C. normative D. marginal