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Problem : What does the CPI measure?

The CPI measures the cost of living based on the relative cost of a fixed based of goods and services consumed by a typical consumer in a country.

Problem :

Using the figure above, compute the CPI for Country C in year 1 using year 1 as the base year.

CPI = (\$0.50 + \$1) / (\$0.50 + \$1) = 100

Problem : Using figure 1, compute the CPI for Country C in year 2 using year 1 as the base year.

(\$1 + \$2) / (\$0.50 + \$1) = 200

Problem : What is the percent increase in the price level in Country C from year 1 to year 2?

Percent increase in CPI = (CPI2 - CPI1)
CPI1 = [(\$0.50 + \$1) / (\$0.50 + \$1)] X 100 = 100
CPI2 = [(\$1 + \$2) / (\$0.50 + \$1)] X 100 = 200

Percent increase in CPI = (200 - 100) = 100%

Problem : What are 3 problems with CPI?

The 3 major problems with the CPI are its inability to deal with the substitution bias, the introduction of new items, and the changes in the quality of items over time.