The substitution bias in the consumer price index refers to the: a. substitution

Question

The substitution bias in the consumer price index refers to the:

a. substitution by consumers toward new goods and away from old goods.

b. substitution by consumers toward a smaller number of high-quality goods and away from a larger number of low-quality goods.

c. substitution by consumers toward goods that have become relatively less expensive and away from goods that have become relatively more expensive.

d. substitution of new prices for old prices in the CPI basket of goods and services from one year to the next.

Explanation / Answer

C)substitution by consumers toward goods that have become relatively less expensive and away from goods that have become relatively more expensive.

Substitution bias - when the price of a product in the consumer basket increases substantially, consumers tend to substitute lower-priced alternatives. For example, if a freeze in Florida causes the price of oranges to skyrocket, consumers may substitute Texas grapefruits for Florida oranges. Since the CPI is a fixed-weight price index, it would not accurately predict the impact of the price increase on the consumer's budget.

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