Suppose manufacturers introduce a new model car to replace a car currently included in the CPI basket. The price of the new car is 10 percent higher than the discontinued model, but the new car also includes additional safety features. In this situation the CPI will tend to ______ inflation as a result of ______ bias.
A) overstate; substitution
B) understate; quality adjustment
C) accurately measure; substitution
D) overstate; quality adjustment

Question

Quizplus · Accepted Answer

The CPI will tend to overstate inflation because it does not fully account for the improved quality of the new car model, leading to a quality adjustment bias.

Suppose Manufacturers Introduce a New Model Car to Replace a Car