Question

Which of the following situations illustrate the problem of substitution bias in the construction of the CPI? Check all that apply.
A) More scoops of raisins in each package of Raisin Bran
B) Greater use of fuel-efficient cars after gasoline prices increase
C) The invention of cell phones
D) Increased personal computer purchases in response to a decline in their price
E) The introduction of air bags in car

Answer 1

Answer:

B) Greater use of fuel-efficient cars after gasoline prices increase

D) Increased personal computer purchases in response to a decline in their price

Explanation:

Substitution bias refers to the fact that economists don't consider that consumers can switch from expensive products to cheaper ones when determining the consumer price index (CPI) basket.

In this case, consumers are buying less gasoline because they are using more fuel efficient vehicles. This should lower the relative weight of gasoline in the CPI basket.

If we went back a few years ago, the PC sales were increasing a lot due to lower prices, so its relative weight in the CPI basket should have increased. That stopped when the smartphones became popular, so the PC's relative weight in the CPI basket should decrease.