Question

Because the CPI is based on a fixed basket of goods, the introduction of new goods and services in the economy causes the CPI to overestimate the cost of living. This is so because ____

Answer 1

CPI does not consider consumer's preference for cheaper substitutes.

Step-by-step explanation:

CPI or consumer price index is used to measure fluctuations in the price level. It is based on a fixed basket of goods. So when the price of these goods increases, it is assumed that the cost of living has increased.

If the new goods introduced are cheaper substitutes for goods already included in the CPI, the consumer will demand the new goods instead of their expensive alternatives. So even if the price of goods in the basket of goods will increase, the cost of living will not.

But the introduction of new goods and services is not included in CPI. This causes overestimation of the cost of living.