This example illustrates the index number problem. Suppose John consumes only bread. In Year 0, John buys four loaves of white bread and four of dark bread, all at $1 each. John likes both equally. In Year 1, white bread costs $2 but dark bread still costs $1. So John switches to dark bread.

a. What has happened to John’s cost of living?

b. What will the values be for a price index using Year 0 as the base year? Does it overstate or understate the true increase in John’s cost of living?