Substitution bias

Substitution bias

Substitution bias describes a bias in economics index numbers arising from tendency to purchase inexpensive alternatives for expensive items when prices change.

Substitution bias occurs when two or more items experience a change of price relative to each other. Consumers will consume more of the now comparatively inexpensive good and less of the now relatively more expensive good. This influences the CPI basket. IF a selected good is bought by consumers and it is therefore included in the CPI basket,but when a sale occurs customers may buy a different product because it is cheaper, while the CPI basket does not change. If product A is purchased by most consumers, and product B has a sale making it cheaper, consumers will naturally buy what is cheaper.

Because of its effect on consumption, substitution bias can cause inflation to be overestimated.


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