Question

Imagine that the government statisticians who calculate the inflation rate have been updating the basic basket of goods once every 10 years, but now they decide to update it every five years. How will this change affect the amount of substitution bias and quality/new goods bias?

Answer 1

Change in substituting the basic basket of goods and services from each 10 years to each 5 years would reduce the amount of substitution bias and quality/new goods bias because of several reasons. Firstly, it will take into account that consumers may substitute products with increasing prices for other cheap products. Secondly, it will be updated with new inventions that might create new products. Thirdly, it will consider improvements to make higher quality products. Therefore, it will take into account that a rise in the price level of goods and services does not necessarily show an inflation.

Inflation can be accurately measured by updating baskets of goods and services everyday.