Question

Inflation Issues

• Does the base basket used to create the CPI precisely reflect your individual choices? If the answer is no, do the inflation rates calculated using the CPI represent the changes in purchasing power that you actually experience?
• Do you substitute between goods as one becomes more expensive, i.e., would you buy more of a less expensive good if the price of your first choice rose significantly? If the answer is yes, does the CPI inflation rate represent the decrease in purchasing power that you actually experienced?
• Based on your answers to the above, does the choice of the market basket matter?

Answer 1

The CPI market basket was created on the basis of surveys of consumer spending. The Bureau of labor statistics , based on surveys chose 200 categories of goods and services to monitor.The CPI increases or decreases on the basis of price movements in the market basket.The base basket used to create the CPI does not reflect individual choice but are chosen randomly.

The CPI measures the average change in prices over a period of time that consumers pay for basket of goods and services , which is called inflation.Thus it measures the purchasing power of a country's unit of currency.

Yes ,people would subsitute more expensive goods for less expensive goods.Purchasing power describes the quantity of goods and services that a dollar can purchase.Decreasing purchasing power means inflation .If the prices rise and the consumers substitute the products for cheaper products ,the CPI formula becomes biased and does not measure inflation or decrease in purchasing power accurately.CPI overstate the inflation rate.

CPI is determined by comparing the prices of fixed basket of goods and services in two different periods.CPI has undergone numerous changes to remove biasness that overstate the inflation rate .Consequently it has become cost of living index which measures the cost to maintain a constant standard of living. So CPI market basket does not matter.