Studyledge

Economic Growth, Unemployment and Inflation: Question 9

Syllabus 4.6

Multiple choice AS 1 mark

Government statisticians in a country calculate the consumer price index (CPI) each month, using a basket of goods and services and expenditure weights taken from a national household expenditure survey.

Which of the following best describes a genuine limitation of using this CPI to measure the change in the cost of living faced by any one particular household?

Choose an answer to check it, then compare with the worked solution below.
Show worked solution Hide worked solution

Worked solution

Step 1: Recall how the CPI is constructed

The CPI is built from a basket of goods and services, with each item weighted according to its share of spending by an average household, as recorded in a national household expenditure survey. This makes it a useful summary measure of price changes facing the economy as a whole, but it is still based on one representative, average pattern of spending.

Step 2: Check option A against this

Because the weights represent an average household, they will not exactly match the spending pattern of any specific household whose consumption looks different from that average, for example, a retired household spending an unusually large share of its budget on heating and healthcare rather than the items an average (often younger, working) household spends most on. If the prices of the goods a particular household relies on heavily rise faster (or slower) than the CPI basket as a whole, the CPI will understate or overstate the true change in that household’s own cost of living. This is a genuine, well-recognised limitation.

Step 3: Rule out options B, C and D

  • Option B simply describes how the CPI is calculated (weighting by average spending shares). This is an accurate statement of the CPI’s methodology, not a limitation in itself.
  • Option C is factually incorrect: the whole purpose of calculating the CPI regularly (for example, every month) is to allow price levels to be compared over time.
  • Option D overstates the CPI’s accuracy: because it is based on an average household’s basket, it does not match every individual household’s experience exactly. This is the opposite of a limitation, and is itself false.

Final answer

Option A, because the CPI’s basket and weights reflect an average household’s spending, it may not accurately capture the true change in the cost of living for a household whose own spending pattern differs from that average, unlike the methodological description in B or the false claims in C and D.