13. Explain why the Paasche index will generally understate the ideal cost-of-living index. The Paasche index measures the current cost of the current bundle of goods relative to the base year cost of the current bundle of goods. The Paasche index will understate the ideal cost-of-living index because it assumes the individual buys the current year bundle in the base period. In reality, at base year prices the consumer would have been able to attain the same level of utility at a lower cost by altering his or her consumption bundle in light of the base year prices. Since the base year cost is overstated, the denominator of the Paasche index will be too large and the index will be too low, or understated. Exercises 1. In this chapter, consumer preferences for various commodities did not change during the analysis. In some situations, however, preferences do change as consumption occurs. Discuss why and how preferences might changeover time with consumption of these two
