assuming a constant price,resulting in a corner solution.With a corner solution,the equal marginal principle cannot hold. 13.The price of computers has fallen substantially over the past two decades Use this drop in price to explain why the Consumer Price Index is likely to overstate substantially the cost-of-living index for individuals who use computers intensively. The consumer price index measures the cost of a typical basket of goods purchased by the omer in ofthe basket in the base year.Each good which reflects the importance the good to the consumer,and the weights are kept fixed from year to year.The problem with fixing the weights is that consumers will shift their purchases from year to year to give more weight to goods whose prices have fallen.and less weight to goods whose prices have risen.The CPl will therefore give too much weight to goods whose prices have risen,and too little weight to et will understate the importance of this good.and will hence understate the effect of the fall in the price of computers.The CPI will overstate the rise in the cost of living for this type of individual. 14.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 Pa sche i index will understate the ideal cost of living because it assumes the individual will buy 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 their consumption bundle. Since the base year cost is overstated,the denominator will be larger and the index will be lower,or understated. 二、EXERCISES 1.In this chapter,consumer preferences for various commodities did not change during the analysis. Yet in some situations,preferences do change as consumption occurs.Discuss why and how preferences might change over time with consumption ofthese two commodities: a.cigarettes The assumption that preferences do not change is a reasonable one if choices are independent across time.It does not hold,however,when"habit-forming"or addictive behavior is involved, as in the case ofcigarettes:the consumption ofcigarettes in one period influences their consumption in the next period assuming a constant price, resulting in a corner solution. With a corner solution, the equal marginal principle cannot hold. 13. The price of computers has fallen substantially over the past two decades. Use this drop in price to explain why the Consumer Price Index is likely to overstate substantially the cost-of-living index for individuals who use computers intensively. The consumer price index measures the cost of a typical basket of goods purchased by the consumer in the current year relative to the cost of the basket in the base year. Each good in the basket is assigned a weight, which reflects the importance of the good to the consumer, and the weights are kept fixed from year to year. The problem with fixing the weights is that consumers will shift their purchases from year to year to give more weight to goods whose prices have fallen, and less weight to goods whose prices have risen. The CPI will therefore give too much weight to goods whose prices have risen, and too little weight to goods whose prices have fallen. For the individual who uses computers intensively, the fixed weight for computers in the basket will understate the importance of this good, and will hence understate the effect of the fall in the price of computers. The CPI will overstate the rise in the cost of living for this type of individual. 14. 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 because it assumes the individual will buy 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 their consumption bundle. Since the base year cost is overstated, the denominator will be larger and the index will be lower, or understated. 二、EXERCISES 1. In this chapter, consumer preferences for various commodities did not change during the analysis. Yet in some situations, preferences do change as consumption occurs. Discuss why and how preferences might change over time with consumption of these two commodities: a. cigarettes The assumption that preferences do not change is a reasonable one if choices are independent across time. It does not hold, however, when “habit-forming” or addictive behavior is involved, as in the case of cigarettes: the consumption of cigarettes in one period influences their consumption in the next period