CPI Quality Adjustment Bias
One important bias in the CPI is
its measurement of price changes
but not quality changes
True or False?
1. A new PC with 20% more memory,
computational speed and data
storage capabilities costs 20% more
and higher public transportation
fares resulting from higher quality
public transportation such as aircon
buses and aircon bus depots will
increase the CPI, and the resulting
higher CPI gives us an accurate
indicator of an increase in the cost
of living for citizens.
2. Cheaper generic drugs became
available this year due to the expiry of
patents held by pharmaceutical
companies. This development will
translate to a lower CPI this year
compared to previous years when
these cheaper generic drugs were not
available in the market.
CPI Substitution Bias
CPI uses a fixed basket of goods and services
When the price of a good increases, consumers buy less and substitute other
goods
Failing to account for substitution overstates inflation
Example: base year cost of basket
Item
2010 price
2010 Spending
Coffee (50 cups)
$1.00
$50.00
Tea (50 cups)
$1.00
$50.00
Scones (100)
$1.00
$100.00
Total
$200.00
In 2015, coffee and scones are more
expensive
Buying exactly the same basket of
goods costs $300, compared to
$200 in 2010
Actually, consumer substitutes coffee with
tea
Scone purchases remain constant
"True" CPI for consumer is
Official CPI estimate of _ is _% higher
than the consumer's actual experience
CPI =
Item
2015 price
2015 Spending
Coffee (50 cups)
$2.00
$100.00
Tea (50 cups)
$1.00
$50.00
Scones (100)
$1.50
$150.00
Total
$300.00
