The Consumer Price Index:

Question

BlackTom AI · Accepted Answer

The CPI measures the cost of a fixed basket of goods and services purchased by typical urban consumers, so it tracks prices paid by consumers in the domestic country.

1. Relevant knowledge points and concepts
- Consumer Price Index (CPI): an index that measures changes over time in the price level of a market basket of consumer goods and services purchased by households.
- Coverage: CPI uses a basket based on consumer purchasing patterns and includes domestically produced goods and imported goods that consumers buy. It excludes capital goods and intermediate goods used in production.
- Contrast with GDP deflator: the GDP deflator measures prices of all final goods and services produced domestically (regardless of who buys them) and therefore excludes imports but includes investment, government, and export goods.

2. Step-by-step reasoning
- CPI is constructed by selecting a representative basket of goods and services (quantities q_i fixed from a base period) and tracking how the cost of that basket changes as prices p_i change.
- Because the basket is defined by consumer purchases, the CPI measures prices faced by domestic consumers, not prices of production or prices in foreign markets.

3. Calculation formula (intermediate steps)
- Cost of basket in base period: Cost_base = Σ (p_i0 × q_i)
- Cost of basket in current period: Cost_current = Σ (p_it × q_i)
- CPI_t = (Cost_current / Cost_base) × 100
These steps show CPI depends on prices paid by consumers for their basket in the domestic economy.

4. Why the correct answer is correct
- The answer "Reflects the prices of all goods and services bought by consumers in the domestic country" matches the CPI’s purpose: it reflects consumer out-of-pocket prices in the domestic market, including imported items consumers purchase.

5. Why the other options are incorrect
- "Reflects the prices of all goods and services produced domestically": incorrect—this describes the GDP deflator, not the CPI, and it ignores imports.
- "Reflects the prices of all final goods and services produced domestically": again describes the GDP deflator (final domestic production), not consumer purchases.
- "Reflects the prices of all goods and services bought by consumers in a foreign country": incorrect—CPI is concerned with domestic consumers’ purchases, not foreign consumers.

6. Conclusion
The correct choice is "Reflects the prices of all goods and services bought by consumers in the domestic country," which matches the provided answer.

The Consumer Price Index:Single choice

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