Question

The consumer price index (CPI) can be used to measure inflation. There are potential problems with this process though that can result in inflation being overstated or understated. Sort each statement according to whether it would cause inflation to be overstated, understated, or would give an accurate representation of inflation.
a. Mary and Bob replace their old minivan with a new one. The new van costs 15% more than the old van, but the new model has many updated features like a camera to assist with backing up, GPS and better fuel economy.
b. Donna, a confirmed chocoholic, notices that her favorite candy bar shrank in size, but its price stayed the same.
c. Zach loves bagels, but bagels are becoming more expensive so he changes his breakfast routine to include a muffin instead because muffins remain relatively cheap.
d. Chris is an avid runner. He is loyal to one particular brand and buys a new pair of the same shoes every few months. The price of his shoes has doubled in the last 15 years.

Answer 1

Answer:

a. Overstates Inflation.

In the case of Mary and Bob, the CPI would have already increased but in this case the price of the minivan increased as well. This will overstate inflation because it will not measure the general rise in price alone (inflation), it will also measure the rise in price as a result of the new minivan having better features.

b. Understated Inflation

Donna's case represents an understated inflation because the quantity shrank yet the price stayed the same. This means that the price is now buying less quantity than it used to which is inflation because more dollars are now required to buy the previous amount. This was not however recorded as there was no change in price.

c. Overstates Inflation

In the case of Zach, the inflation will be overstated because Zach is no longer buying bagels and is now buying muffins so continuing to use bagels as a representative good in the basket of goods used to calculate CPI would be overstating it.

d. Accurate representation of Inflation

In Chris's case, the increase in the price of the same shoe over the years has been because of a general rise in prices and not because it is a different model. It is the same shoe and its price is rising generally so this is an accurate depiction of inflation.