The following appeared at the Reuters.com blog on March 8, 2011: It\'s time to g

Question

The following appeared at the Reuters.com blog on March 8, 2011: It's time to get personal with inflation. First you have to stop pretending that the government's Consumer Price Index (CPI) is a precise guide to the cost of living. For those on Social Security and workers whose wages are indexed to the CPI (lucky you), the index is a Rosetta Stone, although not a very good one. It may not be an accurate reflection on your cost of living. Do you think that the CPI is a poor guide to the cost of living? Why or why not?

Explanation / Answer

CPI is a poor guide because-

A.It does not take into account the substitution of goods.When goods in the CPI basket becomes expensive people substitute these goods for the cheaper one.But CPI does not consider this important effect and considers consumers are buying the same quantity of expensive goods.

B.CPI is focused only on the buying behaviour of the urban consumers and completely neglects the rural population which is a substantial population of any country.

C.The products on the CPI basket does not change.So new products which are purchased by the consumers in large amounts are excluded from CPI basket.

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