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Is inflation understated? Show more Show less

The Consumer Price Index is a measure of the change in prices consumers pay for different goods over time, and is often used as a benchmark for inflation. However, the inflation levels it suggests are not without controversy, and are often accused of being over- or understated. So what is the truth? And why would it be either?

No, inflation is overstated Show more Show less

Various biases cause inflation to be continually overstated.
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A 'theoretical fixed basket' doesn't reflect what people buy

When prices rise, consumers buy cheaper goods rather than higher priced goods.
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The Argument

Rising prices lead to people substituting certain more expensive goods with cheaper ones. For example, when the price of steak rises, households will often buy more chicken and fish instead. This means that the basket that consumers actually purchase is generally lower than a theoretical fixed basket. Economists refer to this as a substitution effect. The Consumer Price Index in the late 1990s started incorporating the substitution effect using geometric weighting,[1] but it still displays the tendency for inflation to lean towards being overstated.

Counter arguments



[P1] The substitution effect means that the theoretical fixed basket used to calculate CPI overestimates how much the average household ends up spending.

Rejecting the premises


Further Reading



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This page was last edited on Friday, 17 Apr 2020 at 12:17 UTC