Question

8. An article in the Wall Street Journal asks the question "How can inflation be low when everything is so expensive?” The article also notes that “The CPI shows that prices are the highest they've ever been.” Is there a contradiction between a low inflation rate as measured by the CPI and the observations that prices are the highest they've ever been” and everything is so expensive”? Carefully Explain.

Answer 1

8.

There is a contradiction, because CPI is based on certain types and category of products that are usually consumed by the individuals and it does not consider everything that is produced in the economy. So, a variation in results takes place. If a product is very expensive, but not included in CPI based basket, then CPI will reflect low inflation rate even if the particular goods are very expensive. Further, CPI does not give attention to the quality. So, a high quality product will be expensive in nature, but it will not be considered in CPI. So, CPI will show low inflation, but a price of quality product can be found to be expensive in nature. Besides, Veblen goods are always expensive and are not considered as a part of CPI basket. Further, CPI is the average of the last few weeks, that also understates the price level in the economy. So, a contradiction is created in the economy between CPI and price of some goods.