Answer to Question #235569 in Macroeconomics for Ross

Question

Review the discussion of bias in the CPI. Explain why failure to consider the quality improvement of a new good leads to an upward bias in the trend of the CPI. Pick a good you are familiar with. Explain how its quality has changed and why it might be difficult for a price index to capture the increase in quality.

Answer 1

CPI overstates inflation based on biases such as;

1. Substitution bias

If a product's price substantially increases, customers usually substitute the product with the one with lower price.

2. Quality bias

As time goes by, everything tends to advance, which increases product's usefulness and life.

In the current world, people are much into the quality of work. Therefore, when quality is not considered, accuracy of the work done tends to diminish hence leads to poor performance.