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Price Level

  • CPI measures the average price for a defined "basket" of goods and services that represents the purchasing patterns of a typical urban household.
  • CPI = [(cost of basket at current prices) /

(cost of basket at base period prices)] x 100

CPI bias – CPI overstates inflation due to:

  • New goods: Older products replaced by newer but initially more expensive products
  • Quality changes: If the price of a product increases because the product has improved
  • Commodity substitution: When 2 goods are substitutes for each other, consumers increase their purchases of the relatively cheaper good & buy less of the relatively more expensive good.
  • Outlet substitution: When consumers shift their purchases toward discount outlets & away from convenience outlets, they reduce their cost of living in a way the CPI does not capture.

Sample Question



Price of common salt was 5 cents in year 1990 and is presently sold at 20 cents. During the same period CPI has increased from 154.5 to 365.8. What has been the change in real price of salt over this period?


CPI Multiplier = 365.8/154.5 = 2.36, CPI Adjusted Salt Price = 5*2.36 = 11.8, Real Increase = 20/11.8 => 69.5%

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