Tutorial 2 answers

Measuring the cost of living
1.The GDP deflator reflects the prices of all final goods and services
produced in the economy, while the CPI reflects the prices of goods
and services purchased by typical consumers. Also, the GDP deflator
uses a variable basket of goods and services—those produced in the
current year, while the CPI uses a fixed basket of goods and services—
those purchased in the base year.The GDP deflator and the CPI differ in
two important ways. The GDP deflator uses as a basket of goods all
final goods and services produced in the domestic economy, while the
CPI basket includes goods and services purchased by typical
consumers. Therefore, changes in the price of imported goods affect
the CPI, but not the GDP deflator. Also, changes in the price of
domestically produced capital goods affect the GDP deflator, but not
the CPI. Changes in the price of domestically produced consumer
goods are likely to affect the CPI more than the GDP deflator because it
is likely that those goods make up a larger part of consumer budgets
than of GDP.

1. Cost of the basket of goods in each year

2001 ($1 x 4) + ($0.50 x 2) = $5
2002 ($2 x 4 ) + ( $1.00 x 2) = $10
2003 ($3 x 4) + ( $1.50 x 2 ) = $15

Consumer price index ( 2001 = 100)
2001 ($5/$5 ) x 100 = 100
2002 ($10/$5) x 100 = 200
2003 ($15/$5) x 100 = 300

Inflation rate
2002 (200 – 100)/100 x 100 = 100%
2003 (300 – 200) / 200 x 100 = 50%

(2) the introduction of new goods.000 x (160/52) = $246.85 . A’s salary in 2000 dollars = Salary in 1930 dollars x (Price level in 2000 / Price level in 1930) = $80. The three problems in the consumer price index as a measure of the cost of living are: (1) substitution bias.2. and (3) unmeasured quality change. 3. which are not reflected quickly in the CPI.153. which arises because people substitute toward goods that have become relatively less expensive.