Weighting Goods by Spending Share in CPI

Steps:

• Identify the purpose of CPI: measures average price changes for a basket of goods and services.
• Recognize that spending patterns vary: some goods like housing consume more budget than others like candy.
• Recall CPI construction: uses a fixed basket weighted by expenditure proportions from surveys.
• Determine the method: higher-spending goods get higher weights to reflect their economic impact.

Why B is correct:

• CPI formula assigns weights based on average household expenditure shares, ensuring the index accurately tracks cost-of-living changes (e.g., Laspeyres index: ∑(p_t * q_0 * w_i) / ∑(p_0 * q_0 * w_i), where w_i is the weight).

Why the others are wrong:

• A: Deducting goods would exclude items, distorting the basket's representativeness.
• C: Averaging price fluctuations ignores spending proportions, leading to unweighted volatility.
• D: Price elasticity measures demand responsiveness, not spending shares for indexing.

Final answer: B