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. Identify 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 can costs 15% more than the old one, but the new model has many updated features like a camera to assist with backing up, GPS, and better fuel economy.
b. Chris is an avid runner. He is loyal to one particular brand and buys a new pair of the same shoe every few months. The price of his shoes has doubled in the last 15 years.
c. Donna, a confirmed chocoholic. notices that her favorite candy bar shrank in size, but its price stayed the same.
d. 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.

Statement A would cause inflation to be overstated.

Statement B gives an accurate representation of inflation.

Statement C would cause inflation to be understated.

Statement D would cause inflation to be overstated.

The consumer price index (CPI) measures inflation by calculating the changes in price of a basket of good.  

CPI = (cost of basket of goods in current period / cost of basket of goods in base period) x 100

Inflation can be described as persistent increase in the general price levels of goods and services produced in an economy.

Statement A would cause inflation to be overstated. This is because the CPI does not factor changes in the features of the minivan into its calculation. The increase in the price of the new minivan might be due to more features in the minivan and not because of inflation

Statement B gives an accurate representation of inflation. Chris buys the same brand of shoes with the same quality regularly. If the price of the shoes doubled, it could be as a result of a rise in price of production.

Statement C would cause inflation to be understated. Let assume that initially, a 20g of candy costs $100. Cost per gram is $5. Now, a 10g of the same candy still costs $100. Cost per gram is $10. So, even though the size of the candy has shrunk, it still costs the same price. Because CPI does not factor in the size of the good, inflation would be understated.

Statement D would cause inflation to be overstated. When Zach consumes less bagels, it would not be included in his CPI.

To learn more about, consumer price index, please check:

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