Suppose there are only two goods (Good A and Good B) and the average person buys 4 of Good A in a year and 3 of Good B. If, in the base year, the Price of Good A is $5 and the Price of Good B is $10, and in the next year the Price of Good A is $6 and the Price of Good B is $9, one problem with the CPI way of calculating inflation is
A. it understates the importance of Good B in the budget.
B. it fails to recognize that people will substitute (to some degree) Good B for Good A and therefore understates the degree of inflation.
C. it understates the importance of Good A in the budget.
D. it fails to recognize that people will substitute (to some degree) Good B for Good A and therefore overstates the degree of inflation.
Answer: D
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