5. Because follows that: corsumers can often substitute cheaper goods for those
ID: 1121453 • Letter: 5
Question
5. Because follows that: corsumers can often substitute cheaper goods for those that have increased in price, ceteris paribus, it B)the CPI overstates inflation. D. the GDP deflator understates inflation the CPI understates inflation. the GDP deflator overstates inflation Current Year (2016) Quant 200 Price 150 ity Price $11 S2 Product uantit 100 200 Tsi2 $4 Grits 6. Refer to the table above. Assume the market basket for the consumer price index has two products-shrimp and grits. Assume the Base Year quantities are also the market basket quantities for calculating the Consumer Price Index. It follows that the Consumer Price Index for 2016 equals: loo( I2 )t 7ool)00 33, 33 100 m) t 200(1)-- 200 133.33 1200 D. 1400 7. Refer back to the previous problem. Suppose that between 2000 and 2016 your annual salary increased from S100,000 to $125,000. It follows that your real income 100,000 133,30 increased C. was unchanged 100 33.33 8.The substitution bias problem associated with the CPI systematically inflation; the int goods problem associated with the CPI systematically inflation; and the unmeasured associated with the CPI systematically quality change problem inflation when the goods' quality improve. AJoverstates; understates; overstates understates; overstates; overstates C. overstates; overstates; overstates D. understates; understates; overstates 9 The price of a sot drink from a vending machine in 2014 is S1.25, Which of the following is correct to find the price of a soft drink in 2014 in 1965 dollars? A. $1.25 x (CPI2014 /CP11965) B. $1.25 x (CPI2014-CP11965) 1.2S $1.25 x (CPI2014 + CPI1965) D 1.25 x (CPI1965/CPI2014)Explanation / Answer
5. B. CPI measures the changes in consumer prices. If consumers substitute cheaper goods for more expensive ones that the cost of living increase will be less, so CPI overstates the inflation.
6.
The real income has decreased since the rate of salary increase is less than inflation.
8. C. Substitution bias, overstates inflation. Consumers substitute less expensive products for more expensive products. CPI is based on the expensive products.
New product bias, overstates inflation. When new products are introduced, dollar value increases, but CPI is based on the fixed basket of currencies.
Unmeasured quality changes, overstates inflation as CPI does not measure the increase in value.
Item Quantity (2000) Base year Price (2000) Base year Quantity (2016) Price 2016 $ market basket in Base year $ market basket in 2016 $ Shrimp 100 11.00 200 12.00 1100 1200 Grits 200 2.00 150 4.00 400 800 1500 2000 Cost of the base year market basket in the base period $1100 + $ 400 = $1500 Cost of the base year market basket in the current period $1200 + $800=$2000 CPI=( Cost of the base year market basket in the current period/Cost of the base year market basket in the base period)x100 (2000/1500)x100 CPI for 2016 =133.33% 7. Inflation rate between 2000 to 2016 (Current period CPI-Prior period CPI)/Prior period CPI (133.33-100)/100 =-0.33 or 33%. Change in income $ Income in 2000 100000 Income in 2016 125000 25000 Rate of increase =(25000/100000)x100 25%The real income has decreased since the rate of salary increase is less than inflation.
8. C. Substitution bias, overstates inflation. Consumers substitute less expensive products for more expensive products. CPI is based on the expensive products.
New product bias, overstates inflation. When new products are introduced, dollar value increases, but CPI is based on the fixed basket of currencies.
Unmeasured quality changes, overstates inflation as CPI does not measure the increase in value.
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