Final answer:
The CPI's imperfections as a cost of living measure include substitution bias, quality/new goods bias, and a one-size-fits-all basket that does not account for individual consumption patterns.
Step-by-step explanation:
The Consumer Price Index (CPI) is an imperfect measure of the cost of living for three main reasons:
- Substitution Bias: CPI is based on a fixed basket of goods and services; however, this approach doesn't account for changes in consumer behavior, such as buying more of less expensive goods and less of more expensive ones, resulting in a potential overstatement of the cost of living changes.
- Quality/New Goods Bias: The CPI basket may not adequately capture the quality improvements or the introduction of new goods that can alter consumer satisfaction and utility, making it less reflective of the actual changes in the cost of living.
- One-Size-Fits-All: The CPI uses an average basket that may not represent the specific consumption patterns of all population segments, leading to possible discrepancies in the cost of living measure for different demographic groups.
Each of these factors can lead to distortions in capturing the true changes in what it costs for people to maintain their standard of living.