A Consumer Price Index (CPI)adjustment overcompensates for inflation because it ignores
A) the income effect when relative prices change.
B) the substitution effect when relative prices change.
C) that some goods are inferior.
D) that the substitution effect may offset the income effect.

Question

Quizplus · Accepted Answer

The CPI adjustment only takes into account the change in prices of the same basket of goods and services, without considering any changes in consumer behavior due to the change in prices (i.e. substitution effect). This can lead to overcompensation for inflation, as consumers may switch to substitute goods that have not experienced as much inflation. The income effect is not relevant in this context, and the fact that some goods are inferior is also not directly related to the issue of CPI overcompensation.

A Consumer Price Index (CPI)adjustment Overcompensates for Inflation Because It