Question

With respect to the consumer price index, the substitution bias arises because:

a. prices of goods and services do not change in the same proportion from year to year.
b. consumers are slow to adjust their buying patterns from year to year in response to price changes.
c. consumers are eager to buy new products as they are introduced, despite their lack of full information about the quality of those products until they buy and use them.
d. All of the above are correct.

Answer 1

Substitution bias occurs because the fixed basket used in CPI calculations does not reflect consumers' ability to substitute cheaper goods when prices rise, leading to an overstatement in the cost of living.

Step-by-step explanation:

The question revolves around the concept of substitution bias within the context of the Consumer Price Index (CPI). The substitution bias arises because an inflation rate calculated using a fixed basket of goods over time tends to overstate the true rise in the cost of living, as it fails to account for the consumer's ability to substitute toward cheaper alternatives when prices for certain goods increase. Therefore, the correct answer to this question is option a: prices of goods and services do not change in the same proportion from year to year, leading to consumers substituting away from goods whose prices have risen substantially.

Answer 2

a. prices of goods and services do not change in the same proportion from year to year.

Step-by-step explanation:

Substitution bias describes a possible bias in economic index numbers if they do not incorporate data on consumer expenditures switching from relatively more expensive products to cheaper ones as prices changed.

Substitution bias occurs when prices of items change relatively to one another. It considers how consumer expenditures are reflected in a consumer price index. Consumers will tend to buy more of the good whose price declined, and less of the now relatively more expensive good.