Discuss four problems with the CPI. Does the CPI tend to overestimate

Discuss four problems with the CPI. Does the CPI tend to overestimate or underestimate the true inflation rate? How big is this bias?

What will be an ideal response?

ANSWER

The CPI tends to overestimate the true inflation rate because it ignores the substitution of cheaper goods for more costly goods, because it ignores unmeasured changes in quality that also lead to increases in price, and because it ignores new products that are often cheaper than existing products. Economists have predicted that the positive bias may be as large as 1.1% a year.