Suppose that the government\'s data collection agency has estimated the prices o

Question

Suppose that the government's data collection agency has estimated the prices of six broad groups of consumer expenditure as well as the average proportions of consumers' income that is spent on these expenditure groups as follows: 2. Prices (base year) Prices (next year) Proportion of income $3300 2500 5000 110 60 330 consumers spend (on average) 30% 25 15 10 10 10 $3000 2500 Shelter Food Transportation 5000 Clothing Entertainment 60 Other 100 300 Compute the average price level in the base year and the next year. (Assume that proportions do not change) The price index for the base year, by definition, is 100. Compute the price index for the next year. You may have noticed that the price of shelter, clothing, and other goods increased by 10 percent each. Does your answer to b) indicate a 10 percent increase in the price index from the base year? Why or why not? a. b. c.

Explanation / Answer

a). Average Price = Total of all prices/no. of groups

Average price in base year = (3000 + 2500 + 5000 + 100 + 60 + 300)/ 6 = 1827

Average price next year = (3300+2500+5000+110+60+330)/6 = 1883

b). Price index = price of current year/price of base year * 100

11,300 /10,960 = 1.031

c). Yes, it is based on the price increase from base year. This is because a percentage increase in price equals = (Change in price level/ base year price) * 100

Percentage of price increase in shelter = (300/3000) * 100 = 10

Percentage of increase in clothes price = (10/100)*100 = 10

Percentage of increase in other goods price = (30/300)*100 = 10

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