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Chapter 24

Measuring the Cost of Living

Educators


Problem 1

Suppose that the year you were born someone bought $100 of goods and services for your baby shower. How much would you guess it would cost today to buy a similar amount of goods and services? Now find data on the CPI and compute the answer based on it. (You can find the BLS's inflation calculator here: http://www.bls.gov/data/inflation_calculator.htm).

Jesse N.
Numerade Educator

Problem 2

The residents of Vegopia spend all of their income on cauliflower, broccoli, and carrots. In 2016, they spend a total of \$200 for 100 heads of cauliflower, \$75 for 50 bunches of broccoli, and $50 for 500 carrots. In 2017, they spend a total of \$225 for 75 heads of cauliflower, \$120 for 80 bunches of broccoli, and $100 for 500 carrots.
a. Calculate the price of one unit of each vegetable in each year.
b. Using 2016 as the base year, calculate the CPI for each year.
c. What is the inflation rate in 2017?

Jesse N.
Numerade Educator

Problem 3

Suppose that people consume only three goods, as shown in this table:
$$
\begin{array}{lrrr}
& & & \text { Bottles of } \\
& \text { Tennis Balls } & \text { Golf Balls } & \text { Gatorade } \\
\hline 2017 \text { price } & \$ 2 & \$ 4 & \$ 1 \\
2017 \text { quantity } & 100 & 100 & 200 \\
2018 \text { price } & \$ 2 & \$ 6 & \$ 2 \\
2018 \text { quantity } & 100 & 100 & 200
\end{array}
$$
a. What is the percentage change in the price of each of the three goods?
b. Using a method similar to the CPI, compute the percentage change in the overall price level.
c. If you were to learn that a bottle of Gatorade increased in size from 2017 to 2018 , should that information affect your calculation of the inflation rate? If so, how?
d. If you were to learn that Gatorade introduced new flavors in 2018 , should that information affect your calculation of the inflation rate? If so, how?

Kaylee M.
Numerade Educator

Problem 4

Go to the website of the Bureau of Labor Statistics (http://www.bls.gov) and find data on the CPI. By how much has the index including all items risen over the past year? For which categories of spending have prices risen the most? The least? Have any categories experienced price declines? Can you explain any of these facts?

Jesse N.
Numerade Educator

Problem 5

A small nation of ten people idolizes the TV show $The \space Voice$. All they produce and consume are karaoke machines and CDs, in the following amounts:

a. Using a method similar to the CPI, compute the percentage change in the overall price level. Use 2017 as the base year and fix the basket at 1 karaoke machine and 3 CDs.
b. Using a method similar to the GDP deflator, compute the percentage change in the overall price level. Also use 2017 as the base year.
c. Is the inflation rate in 2018 the same using the two methods? Explain why or why not.

Jesse N.
Numerade Educator

Problem 6

Which of the problems in the construction of the CPI might be illustrated by each of the following situations? Explain.
a. the invention of cell phones
b. the introduction of air bags in cars
c. increased personal computer purchases in response to a decline in their price
d. more scoops of raisins in each package of Raisin Bran
e. greater use of fuel-efficient cars after gasoline prices increase

Jesse N.
Numerade Educator

Problem 7

A dozen eggs cost \$0.88 in January 1980 and \$2.11 in January 2015. The average wage for production workers was \$7.58 per hour in January 1980 and \$19.64 in January 2015.
a. By what percentage did the price of eggs rise?
b. By what percentage did the wage rise?
c. In each year, how many minutes did a worker have to work to earn enough to buy a dozen eggs?
d. Did workers' purchasing power in terms of eggs rise or fall?

Kaylee M.
Numerade Educator

Problem 8

The chapter explains that Social Security benefits are increased each year in proportion to the increase in the CPI, even though most economists believe that the CPI overstates actual inflation.
a. If the elderly consume the same market basket as other people, does Social Security provide the elderly with an improvement in their standard of living each year? Explain.
b. In fact, the elderly consume more healthcare compared to younger people, and healthcare costs
have risen faster than overall inflation. What would you do to determine whether the elderly are actually better off from year to year?

Jesse N.
Numerade Educator

Problem 9

Suppose that a borrower and a lender agree on the nominal interest rate to be paid on a loan. Then inflation turns out to be higher than they both expected.
a. Is the real interest rate on this loan higher or lower than expected?
b. Does the lender gain or lose from this unexpectedly high inflation? Does the borrower gain or lose?
c. Inflation during the 1970s was much higher than most people had expected when the decade began. How did this affect homeowners who obtained fixed-rate mortgages during the 1960s? How did it affect the banks that lent the money?

Jesse N.
Numerade Educator