ch.24

Question 1

What is the Consumer Price Index (CPI)?

Answer 1

A measure of the overall cost of the goods and services bought by a typical consumer.

Question 2

How is the CPI calculated?

Answer 2

1. Fix the basket
2. Find the prices
3. Compute the basket’s cost
4. Choose a base year and compute the index
5. Compute the inflation rate.

Question 3

What is the formula for calculating the inflation rate?

Answer 3

Inflation rate = (CPI this year – CPI last year) / CPI last year x 100%

Question 4

What is the CPI basket example provided?

Answer 4

10 lbs lamb, 20 lbs chicken

Question 5

What was the CPI basket cost in the base year 2019?

Answer 5

$120

Question 6

What was the CPI in 2020 based on the basket cost?

Answer 6

125

Question 7

What was the inflation rate from 2020 to 2021?

Answer 7

40%

Question 8

What is substitution bias in the context of CPI?

Answer 8

CPI misses the effect of consumers substituting towards goods that become relatively cheaper, overstating increases in the cost of living.

Question 9

How does the introduction of new goods affect the CPI?

Answer 9

It increases variety and makes dollars more valuable, but CPI misses this effect, overstating increases in the cost of living.

Question 10

What is the impact of unmeasured quality change on CPI?

Answer 10

Improvements in quality increase the value of each dollar, but CPI likely misses some of these changes, overstating increases in the cost of living.

Question 11

What is the difference between CPI and GDP deflator regarding imported consumer goods?

Answer 11

CPI includes imported consumer goods; GDP deflator excludes them.

Question 12

What type of basket does the CPI use compared to the GDP deflator?

Answer 12

CPI uses a fixed basket; GDP deflator uses a basket of currently produced goods and services.

Question 13

Which goods are excluded from the CPI but included in the GDP deflator?

Answer 13

Capital goods (if produced domestically).

Question 14

What is indexation?

Answer 14

The automatic correction by law or contract of a dollar amount for the effects of inflation.

Question 15

How do you compare dollar figures from different times?

Answer 15

Amount in today’s dollars = Amount in year T dollars x (Price level today / Price level in year T)

Question 16

What is the nominal interest rate?

Answer 16

The interest rate as usually reported without a correction for the effects of inflation.

Question 17

What is the real interest rate?

Answer 17

The interest rate corrected for the effects of inflation.

Question 18

What is the formula for calculating the real interest rate?

Answer 18

Real interest rate = Nominal interest rate – Inflation rate

Question 19

True or False: The CPI is used to make cost of living adjustments.

Answer 19

True