Question

The typical consumer's food basket in the base year 2015 ls as follows: 30 chickens at $4 each 10 hams at $5 each 10 steaks at $8 each A chicken feed shortage causes the price of chickens to rise to $5.00 each in the year 2016. H ams rise to $7.00 each, and the price of stoaks is unchanged a. Calculate the change in the "cost-of-eating" index between 2015 and 2016 Year 2015 2016 Cost of the basket Instructions: Enter your responses rounded to one decimal place The official cost-of-eating index has ((Click to select) by b. Suppose that consumers are completely indifferent between two chickens and one ham. For this example, how large is the substitution bias in the oficial "cost-of-eating index? The (Cick to select)in the cost-of-eating index is %. The Click to select, B of inflation in the cost of eating reflects substitution bias.

Answer 1

answer b)

The increase in cost of living index is 20 % ,

The overestimation of inflation in cost of living index represents the substitution bias

When the relative prices of goods change then consumers shift towards goods that have become less expensive , but the CPI doesn't take this in to account, thus cpi overstates the increase in cost of living by not considering the substitution bias