Substitution bias is a potential complication that statistical agencies face when trying to calculate the cost of living. A straight-forward way to measure the cost of living is to pick a fixed basket of goods and track the increase in the cost of the basket over time. In practice, when some goods in the basket rise faster than others, consumers will buy less of the more expensive goods and more of the less expensive goods. If statistical agencies ignore consumers’ tendency to substitute more expensive goods with less expensive goods, they will tend to overstate the cost of living.
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