Short Answer 
The process of calculating the cost of a market basket involves determining total costs for each year by multiplying quantities and prices of goods, then calculating price indices based on a base year. Finally, it’s important to analyze how changes in these indices affect nominal income to assess whether living standards have remained stable, taking into account substitution bias and quality improvements.
Step 1: Calculating the Cost of a Market Basket
The first step in determining the cost of a market basket is to calculate the total cost for each year. This involves multiplying the quantities of goods by their respective prices. For example:
- Cost in 2010 = (Quantity of coffee beans in 2010 * Price per unit of coffee in 2010) + (Quantity of cassava in 2010 * Price per unit of cassava in 2010)
- Cost in 2015 = (Quantity of coffee beans in 2015 * Price per unit of coffee in 2015) + (Quantity of cassava in 2015 * Price per unit of cassava in 2015)
Step 2: Calculating Price Indices
Once the costs for each year are determined, the next step is to calculate the price indices using the base year (2010). This is done by dividing the cost of each year by the cost in the base year and multiplying the result by 100:
- Price Index for 2010 = (Cost in 2010 / Cost in 2010) * 100
- Price Index for 2015 = (Cost in 2015 / Cost in 2010) * 100
Step 3: Understanding Changes in Nominal Income
The final step is to analyze how changes in the price index relate to nominal income. The percentage increase in nominal income necessary to maintain the same standard of living should match the percentage increase in the price index. Important factors to consider are:
- Even if the salary increases by 25%, it doesn’t equate to a stable standard of living if consumption patterns change.
- Consideration of issues like substitution bias and quality improvements are essential in evaluating true changes in living standards.