explain four limitations of consumer price index numbers.
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explain four limitations of consumer price index numbers.
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Answer:
Here are some limitations of the Consumer Price Index (CPI):
Substitution bias
The CPI does not account for substitution bias, which occurs when consumers switch to cheaper goods or services as the prices of their preferred goods increase. For example, if the price of peaches increases by 100%, and consumers are indifferent to peaches and other fruits, the increase in the price of food for consumers will be less than 100%.
New products
The CPI does not account for the introduction of new goods and services, which can make it difficult to accurately measure inflation. For example, if a new type of smartphone is released that is more affordable than previous models, the CPI will not capture the decrease in the cost of smartphones.
Quality changes
The CPI does not account for changes in the quality of goods and services, which can also make it difficult to accurately measure inflation. For example, if a new type of car is released that is more fuel-efficient than previous models, the CPI will not capture the decrease in the cost of transportation.
Geographic coverage
The CPI may not be applicable to all population groups or geographic areas. For example, the CPI-U (Urban) better represents the U.S. urban population but doesn't reflect the status of the population in rural areas. CPI doesn't produce official estimates for subgroup
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Answer:
1. Substitution Bias: The Consumer Price Index (CPI) assumes that consumers do not change their consumption patterns in response to price changes. However, in reality, consumers tend to seek alternatives and substitute goods when prices of certain items increase. CPI does not fully account for this substitution behavior, leading to an overestimation of the inflation rate.
2. Quality Changes: CPI does not effectively capture changes in product quality over time. Improvements in the quality of goods and services are not always reflected in CPI calculations, which can lead to an inflation measure that does not accurately reflect changes in purchasing power.
3. Geographical Differences: CPI is designed to provide a national average of price changes, but it may not accurately represent price differences across regions or cities within a country. Different areas may experience varying rates of inflation, making the CPI less relevant for specific geographical locations.
4. New Product Introduction: CPI has limitations in accounting for new products entering the market. It takes time for new products to be included in the CPI calculations, which means that the index may not accurately reflect changes in the availability or pricing of recently introduced items.
These limitations highlight some of the challenges in using CPI as a comprehensive measure of inflation and cost of living adjustments. Adjustments and methodologies are continually being refined to address these issues and improve the accuracy of CPI calculations.
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