Question

Suppose manufacturers introduce a new model car to replace a car currently included in the CPI basket. The price of the new car is 10 percent higher than the discontinued model, but the new car also includes additional safety features. In this situation the CPI will tend to _____ inflation as a result of _____ bias.

Answer 1

Overstate; quality adjustment

Step-by-step explanation:

CPI estimates changes in price of basket of goods over a period of time. In this case, an old model is replaced by new model in the CPI basket that is 10% higher in price but has additional safety features. In this case, CPI will overstate inflation due to quality adjustment bias.

Quality bias happens when new products with advanced features are introduced to the already existing CPI basket.

Answer 2

overstate inflation, substitution bias

Step-by-step explanation:

Suppose automakers are introducing a new design car to replace a vehicle in the CPI basket at the moment. The new car's cost is 10% more than the withdrawn version, but extra safety features are also included in the new car. In this case, as a consequence of substitution bias, the CPI would tend to overstate inflation.