ASSIGNMENT: 2

FOR THE SUBJECT

Macro Economics

Student

S R.# N AME R OLL N UMBER

1 MAAZ ALI BS-20541029

S U B M I T T E D TO. MISS AMNA ASIM

SU B M I S S ION DATE: 02-October-2021
Question For Reviews:
1-4
1. A 10 percent increase in the price of chicken has a greater effect on the consumer price index
than a 10 percent increase in the price of caviar because chicken is a bigger part of the average
consumer's market basket.

2. The three problems that make the consumer price index an imperfect measure of the cost of
living are:
(1) Substitution bias:
which arises because individuals substitute toward goods that have become relatively more
affordable.
(2) Introduction of new goods:
Because consumer price index is based on fixed CPI basket which are not reflected quickly in
the CPI.
(3) Unmeasured quality change:
This problem arises because unmeasured quantity changes in unknown quantity.

3. If the price of a French wine rises, there is effect on the consumer price index, because French
wine are part of consumer goods. And GDP Deflator is not affected, because imported French
wine are not included in GDP.

4.
Data:
Old price of candy bar: $0.20
New price of candy bar: $1.20

Formula:
The price of candy rose= New Price / Old Price

Solution:
$1.20/$0.20

= 6 Times.

The Actual Price of candy = Old price * CPI New / CPI Old

= 0.20 * 300/150
 = $ 0.40

Change in price of a candy bar

New Price – Actual Price / Actual Price * 100

=1.20-0.40/0.40 * 100

=200 Percent

Change in Inflation rate:

Change in Inflation rate= CPI New- CPI Old / CPI Old * 100
(300-150/150) * 100

= 100 Percent

Now Verifying:

($0.40 * 200 %) + $0.40

The price is $1.20

So, the overall price level doubled, but the price of the candy bar rose sixfold, the real price (the price
adjusted for inflation) of the candy bar tripled.

Problems & Applications:

Q3.
a.
Formula: Price of current year- Price of Previous year/Previous year price * 100

The percentage change in the price of tennis balls is (2 – 2)/2 × 100% = 0%.
The percentage change in the price of golf balls is (6 – 4)/4 × 100% = 50%.
The percentage change in the price of Gatorade is (2 – 1)/1 × 100% = 100%.

b. The cost of the market basket in 2014 & 2015 is

Years Tennis Balls Golf Balls Bottles of Gatorade Total

2014 $2 × 100 = $200 $4 × 100 = $400 $1 × 200 = $200 =200+400+200 = $800
 2015 $2 × 100 = $200 $6 × 100 = $600 $2 × 200 = $400 =200+600+400 = $1,200

The percentage change in the cost of the market basket from 2014 to 2015 is
Formula: Total Price of current year- Total Price Previous year/Previous year price *
100
(1,200 – 800)/800 × 100% = 50%.

c. This would lower the calculation of the inflation rate because the value of a bottle of
Gatorade is now greater than before. The comparison should be made on basis of quantity.

d. Yes more flavors enhance consumers well-being. Thus, this would be considered a change in
quality and would also lower my estimation of inflation rate.

Q5.

Data:
CPI Basket:
1 Karaoke Machine
3 Cd’s

a.
The cost of the market basket in 2014 & 2015 is

Years Karaoke Machine CD’S Total

2014 1 × $40 = $40 3 × $10 = $30 =$40+$30= $70

2015 1 × $60 = $60 3 × $12 = $36 =$60+$36= $96

Using 2014 as the base year, we can compute the CPI in each year:

Formula: Price of current year/ Price Base year * 100

 2014 2015
$70/$70 x 100 = 100 $96/$70 x 100 = 137.14

We can use the CPI to compute the inflation rate for 2015:

Formula: Cost of market basket in current year- Cost of market basket in Base year / Cost
of market basket in Base year * 100

Inflation rate= (137.14 − 100)/100 x 100% = 37.14%

b.
NOMINAL GDP:

YEARS Karaoke Machine CD’S Total

2014 10 * $40 = $400 30 * $10 = $300 $400+$300 = $700
2015 12 * $60 = $720 50 * $12 = $600 $720+$600 = $1,320

REAL GDP:

YEARS Karaoke Machine CD’S Total

2014 10 * $40 = $400 30 * $10 = $300 $400+$300 = $700
2015 12 * $40 = $480 50 * $10 = $500 $720+$600 = $980

GDP DEFLATOR:

YEARS GDP Deflator

2014 (700/700) × 100 = 100
2015 (1,320/980) × 100 = 134.69

The rate of inflation for 2015 is:

= (134.69 – 100)/100 × 100% = 34.69%

c.
No, the rate of 2015 inflation rate is not same because it’s calculated by the CPI holds the
basket of goods and services constant because it depends on price, while the GDP deflator
allows it to change because it focusses on quantity.

Q6.

a. Introduction of new goods because new invention of cell phone.

b. Unmeasured quality change because it’s a modification in car.
c. Substitution bias because decline in price of personal computers.
d. Unmeasured quality change because it’s a modification in Raisin Bran.
e. Substitution bias because price rose of substitute.