Using the chart below, list three strengths and three ...



what are the strengths and weakness concerning the consumer price index or CPI? And what are the characteristics of each of these strenghts and weaknesses?

Using the chart below, list three strengths and three weaknesses of the Consumer Price Index calculation.

|Strength |Weakness |

|It turns dollar figures into meaningful measures of purchasing |Substitution Bias: Since the CPI is computed assuming a fixed basket of |

|power. |goods, it ignores the possibility of consumer substitution and, |

|It is used to monitor changes in the cost of living over time. |therefore, overstates the increase in the cost of living from one year |

|It is a measure of the overall cost of goods and services bought|to the next. |

|by a typical consumer. |Introduction of new goods: since when new goods are introduced, |

| |consumers have a wider variety of goods to choose from. This wider |

| |variety makes each dollar more valuable, so consumers need less dollars |

| |to maintain any given standard of living, but since the goods in the CPI|

| |basket is fixed, it does not reflect this change in the purchasing power|

| |of the dollar. |

| |Unmeasured Quality Change: If the quality of a certain good falls – even|

| |if its price remains the same, this signifies a drop in the value of the|

| |dollar, and the opposite is true; and although the BLS tries its best by|

| |adjusting the price of a good to account for the change in quality, the |

| |CPI remains to be inaccurate since quality is hard to measure. |

• Post a response that answers the following questions, once your chart is complete:

• What are the characteristics of the items listed as strengths?

• What are the characteristics of the items listed as weaknesses?

• If the CPI is imperfect, why do we use it?

The Consumer Price Index as defined by Mankiw is a “measure of the overall cost of goods and services bought by a typical consumer.” It is actually a measure that the government uses to report the rate of inflation each month. The Consumer Price Index measures the prices of a market basket of some 300 consumer goods and services purchased by a typical urban consumer. Unlike the GDP Price Index, in which the weights of various goods and services are adjusted continuously, the Consumer Price Index is a historical, fixed weight price index. The idea behind the historical, fixed weight approach is to measure changes in the cost of a constant standard of living. Changes in the CPI thus allegedly measure the rate of inflation facing consumers. The strengths of the CPI arise from the fact that it provides figures that could be easily compared to arrive at the changes in the cost of living. Just like all models, CPI is not a perfect real life measure and in this it suffers some of the weaknesses such as substitution bias, the effects of the introduction of new goods and services, and finally unmeasured quality change. Such weaknesses cause the inflation rate reported by the CPI to be a bit inaccurate nevertheless, the Consumer Price Index remains to be a powerful tool that measures the approximate inflation rate and hence enable the government to adjust some important measures such as minimum wages and transfer payments to compensate for the changes in the purchasing power of the dollar.

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