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Chapter 9: Q 14. (page 243)

Why does “substitution bias” arise if we calculate

the inflation rate based on a fixed basket of goods?

Short Answer

Expert verified

Substitution bias arises because of various reasons.

Step by step solution

01

Step 1. Definition

Substitution bias arises when prices of items change in relation to one another. And in another word, it arises when consumer changed their purchasing behavior in relation to various goods.

02

Step 2.  Explanation

Substitution bias basically arises due to the nature of the basket. As the goods basket is fixed the consumer the value of the index remains the same. But in reality when price increases, people would choose to consume a cheaper substitute of the good.

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Most popular questions from this chapter

Describe a situation, either a government policy situation, an economic problem, or a private sector situation, where using the CPI to convert from nominal to real would be more appropriate than using the GDP deflator.

22. Inflation rates, like most statistics, are imperfect

measures. Can you identify some ways that the inflation rate for fruit does not perfectly capture the rising price of fruit?

If a government gains from unexpected inflation when it borrows, why would it choose to offer indexed bonds?

Name several forms of indexing in the private and

public sector.

Why is the GDP deflator not an accurate measure of inflation as it impacts a household?
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