Question

In the context of inflation, which best describes substitution bias? Evaluating the price of a basket of goods over time does not account for changes that consumers make when the price of a particular good increases. Inflation is best measured by comparing the price of a single good over time. Evaluating the price of a basket of goods over time does not consider the varying tax rates affecting consumers. Inflation affects individual consumers at different rates, so no one measure can be accurate.

Answer 1

Evaluation of the price of the basket of goods with time is not accountable for the changes that are made by the customers on the increase in price of a specific good.

Step-by-step explanation:

Inflation can be defined as the increase in the overall price and it can be measured in terms of CPI, i.e., Consumer Price Index.

CPI is generally measured as the weighted mean of the prices of the goods, basket which is supposedly fixed for two to three years.

In case, the quantity of the sales of the goods increases even if the cost of the goods remains same, the customer will purchase more of these goods and this shows up in the CPI index.

The demand of theses goods may slow down with a rise in the price of these goods where the the basket value remain unchanged resulting in overstate inflation where the customer replaces the goods at high price with that of its competitor with low price.