Question

Why does “substitution bias” arise if we calculate

the inflation rate based on a fixed basket of goods?

Short answer

Substitution bias arises because of various reasons.

Step-by-step solution

Step 1. Definition

Substitution bias arises when prices of items change in relation to one another. And in another word, it arises when consumer changed their purchasing behavior in relation to various goods.

Step 2.  Explanation

Substitution bias basically arises due to the nature of the basket. As the goods basket is fixed the consumer the value of the index remains the same. But in reality when price increases, people would choose to consume a cheaper substitute of the good.