Assume that after you graduate, you move to a simple economy in which only three

Question

Assume that after you graduate, you move to a simple economy in which only three goods are produced and consumed: fish, fruit, and meat. Suppose that on January 1, fish sold for $2.50 per pound, meat was $3.00 per pound, and fruit was $1.50 per pound. At the end of the year, you discover that the catch was low and that fish prices had increased to $5.00 per pound, but fruit prices stayed at $1.50 per pound, and meat prices had actually fallen to $2.00. Can you say what happened to the overall CPI, in terms of whether it increased, decreased, or stayed the same? Do you have enough information to calculate the inflation rate?

Explanation / Answer

Sum total of prices at the beginning of the year = $2.50 + $3 + $1.50 = $7

Calculate CPI at the beginning of the year -

CPI = [Sum total of prices at the beginning of the year/Sum total of prices at the beginning of the year] * 100

CPI = [$7/$7] * 100 = 100

The CPI at the beginning of the year is 100.

Sum total of prices at the end of the year = $5 + $2 + $1.50 = $8.50

Calculate CPI at the end of the year -

CPI = [Sum total of prices at the end of the year/Sum total of prices at the beginning of the year] * 100

CPI = [$8.50/$7] * 100 = 121.43

The CPI at the end of the year is 121.43.

Thus, the overall CPI has increased.

Calculate the inflation rate -

Inflation rate = [(CPI at the end of the year - CPI at the beginning of the year)/CPI at the beginning of the year] * 100

Inflation rate = [(121.43 - 100)/100] * 100 = 21.43%

The inflation rate is 21.43%.

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