Question

22. Inflation rates, like most statistics, are imperfect

measures. Can you identify some ways that the inflation rate for fruit does not perfectly capture the rising price of fruit?

Short answer

because of substitution bias and new product bias

Step-by-step solution

Step 1. Definition

Inflation is the rate at which prices increase over a period of time.

Step 2. Explanation

See consumers every time prefer to have low-cost goods. And if the price of one fruit increases, they tends to substitute it for another low proceed fruit. So high price goods are not important for consumers in a fixed basket of goods and services required to measure inflation.

Step 3.

Further, if CPI doesn’t include new products, then the inflation measurement can’t be correct. And this happens because consumers think that if they purchase new goods, it will improve their cost of living and welfare. Moreover, new goods with good quality have increased price when they are launched in the market. Thus, CPI doesn’t account for the decline in price generally.

So that’s why the inflation rate for fruit doesn’t perfectly capture the price of food as it doesn’t account for substitution part by consumers which is called substitution bias and new product bias.