1.

Suppose that the year you were born someone bought $100 of goods and
services for your baby shower. How much would you guess it would cost
today to buy a similar amount of goods and services? Now find data on the CPI
and compute the answer based on it. (You can find the BLS’s inflation
calculator here: http://www.bls.gov/data/inflation_calculator.htm.)

According to BLS’s iflation calculator, $100 in 2002 (when I was born) had the same value
as $154.15 compare to recent days (2021)
Based on information on the Internet:
CPI in May 2002: 179.8
CPI in July 2021: 272.26
Then the value of $100 in 2002 is equal to: $100 x (CPI in 2021/CPI in 2002) =
$100x(272.26/179.8) = 151.4 (CPI in July)
2. The residents of Vegopia spend all of their income on cauliflower, broccoli, and
carrots. In 2020, they spend a total of $200 for 100 heads of cauliflower, $75 for
50 bunches of broccoli, and $50 for 500 carrots. In 2021, they spend a total of $225 for
75 heads of cauliflower, $120 for 80 bunches of broccoli, and $100 for 500 carrots.
a. Calculate the price of one unit of each vegetable in each year.
b. Using 2020 as the base year, calculate the CPI for each year.
c. What is the inflation rate in 2021?
a,

Year Price of a Quantity of Price of a Quantity of Price of a Quantity of

head of heads of bunch of bunches carrot carrots
cauliflower cauliflower broccoli of broccoli
2020 2$ 100 1.5$ 50 0.1$ 500
2021 3 75 1.5 80 0.2 500

b,
Year Total cost of the basket CPI
2020 2x100 + 1.5x50 + 0.1x500 = (325/325)x100=100%
$325
2021 3x100 + 1.5x50 + 0.2x500= (475/325)x100=146.15%
$475

c, Inflation rate =( (146.15%-100%)/100%)x100=46.15%

3. Suppose that people consume only three goods, as shown in this table:
 a. What is the percentage change in the price of each of the three goods?
Tennis ball: unchanged
Golf ball: increase (6x100 - 4x100)/ (4x100) x100 = 50%
Bottles of Gatorade: increase (2x200-1x200)/(1x200)x100 = 50%
b. Using a method similar to the CPI, compute the percentage change in the overall
price level.

Choose the base year as 2020

Year Total cost of the basket CPI
2020 2x100 + 4x100 + 1x100 = 700 100
2021 2x100 + 6x100 + 2x200 = 1200 (1200/700)x100=171.43%

-> % change = ((171.34-100)/100)x100 = 71.43%

c. If you were to learn that a bottle of Gatorade increased in size from 2020 to 2021, should
that information affect your calculation of the inflation rate? If so, how?
That information could affect your caculation of the inflation rate. If you were to learn that a
bottle of Gatorade increased in size from 2020 to 2021, that would lower your estimation of
the inflation rate because the value of a bottle of Gatorade is now greater than before. The
comparison should be made on a per-ounce basis rather than with bottles as the unit.
d. If you were to learn that Gatorade introduced new flavors in 2021, should that information
affect your calculation of the inflation rate? If so, how?
Greater variety enhances consumers' well-being, in effect making each dollar more valuable
than it was previously. However, because a price index such as the CPI is based on a fixed
basket of goods, this increase in the value of a dollar is neglected in estimations of inflation,
so inflation is overstated.

4. Go to the website of the Bureau of Labor Statistics (http://www.bls.gov) and find

data on the CPI. By how much has the index including all items risen over the past
year? For which categories of spending have prices risen the most? The least? Have
any categories experienced price declines? Can you explain any of these facts?
https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category.htm#
- The index including all items risen 5.4% over the past year
- Used cars and trucks have prices increase the most (+41.7%)
- Medical care commodities increase the least (-2.1%)
 5. A small nation idolizes the TV show The Voice. All they produce and consume
are karaoke machines and CDs, in the following amounts:

a. Using a method similar to the CPI, compute the percentage change in the overall
price level. Use 2020 as the base year and fix the basket at 1 karaoke machine and 3
CDs.

Year Total cost of the basket (1 CPI

karaoke machine, 3CDs)
2020 (base year) 70 100
2021 96 137.14

➔ %change in total price level: ((137.14-100)/100)x100=37.14%

b. Using a method similar to the GDP deflator, compute the percentage change in the
overall price level. Again, use 2020 as the base year.

Year Total cost of the basket CPI

2020 (base year) 700 100
2021 960 137.14

-> %change in total price = (960-700)/700x100= 37.14%

c. Is the inflation rate in 2021 the same using the two methods? Explain why or why not.
The inflation rate in 2021 is the same using the two methods because in fact the basket just
increase 10 times

6. Which of the problems in the construction of the CPI might be illustrated by each of
the following situations? Explain.
a. the invention of cell phones
-> the phenomenon show the problem of introducing of new goods which CPI can not be a
scale to account for the improvement of standard of living
b. the introduction of air bags in cars
-> the statement show the problem of unmeasured quality change. The CPI will not be able
to account for the improved standard of living due to the development of quality of cars.
c. increased personal computer purchases in response to a decline in their price
It is the problem of substitution bias, CPI is a fixed basket, substitution of old goods with
cheaper price will not be included.
d. more scoops of raisins in each package of Raisin Bran
it is difficult to measure the improvement though increase 1 more unit of raisins. This
statement demonstrate the problem of unmearsured quality changes.
e. greater use of fuel-efficient cars after gasoline prices increase
It is the problem of substitution bias, considering a fuel efficient car as an alternative of
normal car is excluded in the caculation of CPI

7. A dozen eggs cost $0.88 in January 1980 and $1.77 in January 2018. The average
hourly wage for production and nonsupervisory workers was $6.57 in January 1980
and $22.36 in January 2018.
a. By what percentage did the price of eggs rise?
Inflation rate = (1.77-0.88)/0.88x100 = 101.14%
b. By what percentage did the wage rise?
Inflation rate = (22.36-6.57)/6.57x100 = 240.33%
c. In each year, how many minutes did a worker have to work to earn enough to buy a dozen
eggs?
In 1980, people had to work about 8 minutes to afford a dozen eggs ( 0.88/(6.57:60)) = 8.04
In 1980, people had to work about nearly 5 minutes to afford a dozen eggs
(1.77/(22/36:60))= 4.75
d. Did workers’ purchasing power in terms of eggs rise or fall?
The purchasing power of eggs have risen because people in have the ability to buy about 12
dozens eggs in an our of work while people in 2018 could afford about 8 dozens eggs.

8. The chapter explains that Social Security benefits are increased each year in
proportion to the increase in the CPI, even though most economists believe that the
CPI overstates actual inflation.
a. If the elderly consume the same market basket as other people, does Social Security
provide the elderly with an improvement in their standard of living each year? Explain.
-> YES. If the elderly consume the same market basket as other people, Social Security
would provide the elderly with an improvement in their standard of living each year because
the CPI overstates inflation and Social Security payments are tied to the CPI.
b. In fact, the elderly consume more healthcare compared with younger people, and
healthcare costs have risen faster than overall inflation. What would you do to determine
whether the elderly are actually better off from year to year?
-> Because the elderly consume more healthcare than younger people do, and because
healthcare costs have risen faster than overall inflation, it is possible that the elderly are
worse off. To investigate this, you would need to put together a market basket for the elderly
that would have a higher weight on healthcare. You would then compare the rise in the cost
of the "elderly" basket with that of the general basket for CPI.

9. Suppose that a borrower and a lender agree on the nominal interest rate to be paid
on a loan. Then inflation turns out to be higher than they both expected.
a. Is the real interest rate on this loan higher or lower than expected?
-> When inflation is higher than was expected, the real interest rate is lower than expected
because the constant amount of money have less value when inflation happen.
b. Does the lender gain or lose from this unexpectedly high inflation? Does the borrower gain
or lose?
-> The lender lose from this unexpectedly high inflation while the borrower lose because the
real interest rate is lower than was expected. The borrower is repaying the loan with dollars
that are worth less than was expected,whereas the purchasing power of the loan the lender
gets back is lower than was expected.
c. Inflation during the 1970s was much higher than most people had expected when the
decade began. How did this unexpectedly high inflation affect homeowners who obtained
fixed-rate mortgages during the 1960s? How did it affect the banks that lent the money?
-> Homeowners (borrowers) in the 1970s who had fixed-rate mortgages from the 1960s
benefited from the unexpected inflation, while the banks (lenders) that made the mortgage
loans were harmed.
Problem solving:

a,

Year Total cost CPI

2001 (base year) 10x200x2/3 + 30x40 + 300x30 = (12200.67/12200.67)x100=100
12200.67
 2002 11x200x2/3 + 30x40 + 310x30 = (13300.67/12200.67)x100 =
13300.67 109.01
2003 11x200x2/3 + 32x40 + 310x30 = (13380.67/12200.67)x100
13380.67 =109.67

Inflation rate (2002&2003) = ((109.67-109.01)/109.01)x100=0.6%

b,

Year Total cost CPI

2001 10x200x2/3 + 30x42 + 300x30 = (12200.67/12200.67)x100=96.4
11593.33
2002 (base year) 11x200x2/3 + 30x42 + 310x30 = (13300.67/12200.67)x100 = 100
12026.67
2003 11x200x2/3 + 32x42 + 310x30 = (13380.67/12200.67)x100 =100.7
12110.67

Inflation rate (2002&2003) = ((100.7-100)/100)x100=0.7%

c, 210,38,32

Year Total cost CPI

2001 10x210x2/3 + 30x38 + 300x32 = (12140/12676)x100=95.77
12140
2002 11x210x2/3 + 30x38 + 310x32 = (12600/12676)x100 = 99.4
12600
2003 (base year) 11x210x2/3 + 32x38 + 310x32 = (12676/12676)x100 =100
12676

Inflation rate (2002&2003) = ((100-99.4)/99.4)x100=0.6%