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Economics and Economic Change | Online Assignment Help

This question relates to the example given in the lecture on the topic of substitution bias. Suppose the CPI basket for 2010 (base year) is composed of 50 cups of coffee at $2 per cup, 50 cups of tea at $2 per cup and 100 scones at $1 each. In year 2011, a frost hit a major coffee-producing country, causing the price of coffee to double. a. What is the rate of inflation from year 2010 to year 2011? b. Assume consumers like coffee and tea equally well, therefore, the increase in the price of coffee encourages them to forgo coffee and drink tea instead (switch from consuming 50 cups of coffee and 50 cups of tea to consuming 100 cups of tea). What is the adjusted rate of inflation? c. Comparing the results from part (1) and (2), please explain the substitution bias?

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