Question

-- N UUSLU One of the limitations of the CPI is substitution bias. Do you have any examples of making substitutions in your consumption to lower costs? Did this a make a significant change in your cost of living? If substitution bias is widespread, how would this affect CPI estimates?

Answer 1

Substitution bias is one of the bias in the calculation of consumer price index

Other biases are

Effect of quality change

Representation of novelty

In substitution bias, the presence of substitute is there.

As we all know, substitutes are those goods which are replacement to each other

For example, tea and coffee

So in calculation of CPI, when customer find that the substitution price has been lowered then the move to that good but these good might not be added in the market basket and actual value of CPI do not come true.

This create a bias

For example , let say a consumer who generally consume tea but due to hike in the price of tea he shifted to consume coffee

But in the market basket coffee is not added so this will create a bias in the calculation of CPI

It also affects the overall cost of living because cost of living includes the consumption of all goods and services.

It is also very widespread due to this type of shortcoming