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Exam 6: Measuring the Cost of Living

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Question 31

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What does the CPI measure?

A) the overall price of inputs purchased by a typical producer
B) the overall price of goods and services bought by a typical consumer
C) the overall price of goods and services produced in the economy
D) the overall price of shares on the Toronto Stock Exchange

E) None of the above
F) All of the above

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Question 32

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Table 6-5 This table pertains to an economy with only two goods: books and calculators. The fixed basket consists of 5 books and 10 calculators. $\begin{array} { | l | c | c } \hline \text { Year } & \text { price of Bouks } & \text { price of Calculators } \\\hline 2011 & \$ 24 & \$ 8 \\\hline 2012 & \$ 30 & \$ 12 \\\hline 2013 & \$ 32 & \$ 15 \\\hline\end{array}$ -Refer to the Table 6-5.Using 2011 as the base year,what is the consumer price index?

A) 100 in 2011, 135 in 2012, and 155 in 2013
B) 100 in 2011, 270 in 2012, and 310 in 2013
C) 200 in 2011, 270 in 2012, and 310 in 2013
D) 200 in 2011, 540 in 2012, and 620 in 2013

E) A) and B)
F) A) and C)

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Question 33

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Which of the following best defines "indexation"?

Ruth collected pension benefits of $220 a month in 2011.If the price index rose from 90 to 105 in the period 2011-2013,what should her pension benefits for 2013 be?

When the relative price of a good increases,how will consumers respond?

When the quality of a good deteriorates,what happens to the purchasing power of the dollar?

Suppose that the nominal interest rate was 3 percent and the inflation rate was 1 percent.What happened with the value of savings?

Table 6-4 This table shows the CPI for various categories of goods and services. $\begin{array} { | l | l | l | } \hline & \text { Year 1 } & \text { Year 2 } \\\hline \text { Fadd and Beverages } & 168.4 & 173.6 \\\hline \text { Hausing } & 169.6 & 176.2 \\\hline \text { Transpartation } & 153.3 & 154.3 \\\hline \text { Gasoline } & 139.6 & 141.4 \\\hline\end{array}$ -Refer to the Table 6-4.Of those categories,which one had the lowest rate of inflation?

Suppose OPEC succeeds in raising world oil prices by 300 percent.This price increase causes inventors to look at alternative sources of fuel for internal-combustion engines.A hydrogen-powered engine is developed,and it is cheaper to operate than gasoline engines.Which of the following problems in the construction of the CPI would this situation represent,respectively?

Table 6-5 This table pertains to an economy with only two goods: books and calculators. The fixed basket consists of 5 books and 10 calculators. $\begin{array} { | l | c | c } \hline \text { Year } & \text { price of Bouks } & \text { price of Calculators } \\\hline 2011 & \$ 24 & \$ 8 \\\hline 2012 & \$ 30 & \$ 12 \\\hline 2013 & \$ 32 & \$ 15 \\\hline\end{array}$ -Refer to the Table 6-5.Using 2013 as the base year,what is the consumer price index?

In a simple economy,people consume only two goods: food and clothing.The market basket of goods used to compute the CPI has 50 units of food and 10 units of clothing. $\begin{array} { | l | c | c | } \hline & \text { Food } & \text { Clathing } \\\hline \text { Last year's price } & \$ 4 & \$ 10 \\\hline \text { This year's price } & \$ 6 & \$ 20 \\\hline\end{array}$ a.What are the percentage increases in the price of food and in the price of clothing? b.What is the percentage increase in the CPI? c.Do these price changes affect all consumers to the same extent? Explain.

Scenario 6-1 Grant Smith was a doctor. In 1944, he made $12 000. His daughter, Lisa Smith, is also a doctor. Last year she made $175 000. The price index in 1944 was 17.6 and the price index last year was 192. -Refer to the Scenario 6-1.What was the ratio of Grant's real income to Lisa's real income?

Laura bought word processing software for $50.A year later,Laura's twin brother Laurence bought an upgraded version of the same software for $50.Which of the following problems in the construction of the CPI does this situation best represent?

The price index in the first year is 100,in the second year is 90,and in the third year is 80.What is the deflation rate between the first and second year,and between the second and third year?

Suppose the price of CD players increases dramatically,causing a 1 percent increase in the CPI.By how much will the GDP deflator most likely increase?

Which of the following agencies calculates the CPI?

A Brazilian company produces soccer balls in Canada and exports all of them.If the price of the soccer balls increases,what happens to the GDP deflator and the CPI?

Which change in the price index shows the greatest rate of inflation?

The formula to calculate CPI between a base year (say,Year 0)and another,specified year,say Year 1,is CPI=(Expenditure on basket in Year 1)/(Expenditure on basket in Year 0)×100.Suppose an economy produces only two goods,food (f)and clothing (c).Let quantities and prices in Year 0 be qf0,qc0,pf0 and pc0,respectively,and let us adopt similar notations for Year 1,with the caveat that,for CPI,the quantities remain the same as in Year 0. a)Calculate,using the notations in the problem,the expenditure on the basket in Year 0,the expenditure on the basket in Year 1,and the CPI. b)Find the formulas for the share of each of the two goods in the expenditure on the basket in Year 0.Let sf and sc be the two shares.Show that the sum of the two shares is equal to 1.Let us multiply each of these shares by 100 and call them weights,wf and wc.Check that their sum is equal to 100. c)Using the notations wf and wc for the two weights,re-write the CPI formula. d)Replace wf and wc in the formula that you just wrote,and compare the result to the formula of definition for CPI.Are they identical? If not,what changes do you need to make in order to make them identical? e)Did you need to know quantities in Year 1 in order to compute CPI?

Substitution bias in computing the CPI tends to make the CPI overstate the true increase in the cost of living.