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2. The price level measures the cost of a basket of goods and services, relative to a base
year. The CPI is one standard measure of the price level. In contrast, the rate of
inflation is the annual percentage change in the price level.
For example, suppose that the basket of goods and services on which the CPI is
based cost $100 in the base year, $150 last year, and $154.50 this year. The price
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level this year is 1.545 (=$154.50/$100.00). The inflation rate from last year to this is
the percentage increase in the cost of the basket since last year,
4. In an indexed labor contract, wages each year would automatically be increased at the
rate of inflation, preserving the purchasing power of the agreed-upon wage. For
example, if prices of consumer goods rise by 2% over the year (that is, the rate of
inflation is 2%), an indexed wage will also automatically rise by 2% so that the
quantity of goods the worker can purchase remains unchanged.
2
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medical procedures), the harder they are to measure precisely, which increases the
risk of overstating inflation.
Second, substitution bias occurs because the CPI assumes a fixed basket of goods
and services that does not allow for the possibility of consumer substitution of less
expensive items for more expensive ones. For example, if a particular type of candy
bar is included in the official basket, and the price of this candy bar rises, then an
increase in the official cost of living will be recorded. However, if people can switch
from one type of candy bar to another desirable that has not increased in price, then
the “true” cost of living will not have risen despite what the CPI shows.
6. The first two sentences are correct; the losses that unanticipated inflation imposes on
creditors (for example) are just offset by the gains to debtors. The third sentence is
not correct, however, as there is an overall cost to society when wealth is redistributed
arbitrarily. First, the role of luck in the distribution of income is increased since the
size of one’s return depends on whether inflation is high or low; this makes people
feel worse off and is a cost to society. Second, when wealth is determined more by
random forces than by hard work and intelligent investment, the incentives to engage
in the latter are reduced, harming the efficiency of the economy. Finally, people use
up resources attempting to anticipate inflation and protect themselves against it; from
society’s point of view, these resources are wasted.
7. The real return on any asset is the nominal return (or nominal interest rate) minus the
inflation rate. The nominal return on cash is zero, so the real return equals the
nominal interest rate minus the inflation rate. That is, the return to cash is negative
whenever there is inflation, and each additional point of inflation reduces the real
return to holding cash (i.e. makes it more negative) by one point.
8. True. Suppose the borrower and lender agree on a 2% real return on the loan. If they
correctly anticipate that inflation over the life of the loan will be, say, 5%, then setting
a 7% nominal interest rate on the loan ensures that the lender receives and the
3
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
borrower pays a 2% real return, as agreed beforehand. (Note that this ignores any
complications introduced by differential in taxes between the borrower and lender.)
Answers to Problems
1.
a. The cost of the goods in the base year is $200 + $600 + $100 + $50 = $950. In
the subsequent year the same goods costs $220 + $640 + $120 + $40 = $1,020.
The CPI in the subsequent year equals the cost of the goods in that year relative to
$1020
the base year: = 1.074 . Since the CPI in the base year is 1.000, the rate of
$950
inflation (equal to the percentage increase in the CPI) between the base year and
the subsequent year is 7.4%.
b. The family’s nominal income rose by 5%, which is less than the increase in the
family’s cost of living. The family is thus worse off in terms of real purchasing
power.
2. The inflation rate between 1990 and 1991 is the percentage increase in the price level
between those years: (136.2 -130.7)/ 130.7 = 4.2%. Inflation rates for the years 1991
through 2000 are presented below.
Inflation Rate
Year CPI (%)
1990 130.7
1991 136.2 4.2
1992 140.3 3.0
1993 144.5 3.0
1994 148.2 2.6
1995 152.4 2.8
1996 156.9 3.0
1997 160.5 2.3
1998 163 1.6
1999 166.6 2.2
2000 172.2 3.4
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The inflation rates were relatively low throughout the 1990s, but lower at the end of the
decade than at the beginning.
3. a. Using the CPI data from problem 2, the real entry-level wage for college graduates
$13.65
in 1997 was = $8.50
1.605
b. Since the real wage fell by 8% between 1990 and 1997, the $8.50 real wage in
1997 was 92% of the real wage in 1990:
8.50 = (0.92)(real wage in 1990)
➔ Real wage in 1990 = $9.24
c. Let W1990 stand for the nominal wage in 1990. Then, if we deflate the nominal
W
wage by the CPI, we have 1990 = $9.24 . Solving for W1990 gives us a nominal
1.307
wage in 1990 of $12.08.
4. The rate of inflation between 2014 and 2015 (the percentage increase in the price
185 − 175 10
level) is = = 0.057 = 5.7%. To keep tax brackets at the same points in
175 175
terms of real income, the nominal income categories should each be increased by
5.7%. The tax schedule for the year 2016 is:
Note: If you calculated the inflation rate to more decimal points, your answers will be
slightly different from those above.
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raised to the throne of Armenia a person of the same name. Tacitus,
Annals, bk. 2.
Artaxa and Artaxias, a general of Antiochus the Great, who erected the
province of Armenia into a kingdom, by his reliance on the
friendship of the Romans. King Tigranes was one of his successors.
Strabo, bk. 11.
Artĕmis, the Greek name of Diana. Her festivals, called Artemisia, were
celebrated in several parts of Greece, particularly at Delphi, where
they offered to the goddess a mullet, which, as was supposed, bore
some affinity to the goddess of hunting, because it is said to hunt and
kill the sea-hare. There was a solemnity of the same name at
Syracuse; it lasted three days, which were spent in banqueting and
diversions. Athenæus, bk. 7.
Artōna, a town of the Latins, taken by the Æqui. Livy, bk. 2, ch. 43.
Aruntius, a Roman who ridiculed the rites of Bacchus, for which the
god inebriated him to such a degree that he offered violence to his
daughter Medullina, who murdered him when she found that he acted
so dishonourably to her virtue. Plutarch, Parallela minora.――A
man who wrote an account of the Punic wars in the style of Sallust,
in the reign of Augustus. Tacitus, Annals, bk. 1.—Seneca,
ltr. 14.――Another Latin writer. Seneca, de Beneficiis,
bk. 6.――Paterculus, a man who gave Æmylius Censorinus tyrant of
Ægesta a brazen horse to torment criminals. The tyrant made the first
experiment upon the body of the donor. Plutarch, Parallela
minora.――Stella, a poet descended of a consular family in the age
of Domitian.
Ascălon, a town of Syria, near the Mediterranean, about 520 stadia from
Jerusalem, still in being. It was anciently famous for its onions.
Josephus, The Jewish War, bk. 3, ch. 2.—Theophrastus, Enquiry into
Plants, bk. 7, ch. 4.
Ascănius, son of Æneas by Creusa, was saved from the flames of Troy
by his father, whom he accompanied in his voyage to Italy. He was
afterwards called Iulus. He behaved with great valour in the war
which his father carried on against the Latins, and succeeded Æneas
in the kingdom of Latinus, and built Alba, to which he transferred the
seat of his empire from Lavinium. The descendants of Ascanius
reigned in Alba for above 420 years, under 14 kings, till the age of
Numitor. Ascanius reigned 38 years; 30 at Lavinium, and eight at
Alba; and was succeeded by Sylvius Posthumus son of Æneas by
Lavinia. Iulus the son of Ascanius disputed the crown with him; but
the Latins gave it in favour of Sylvius, as he was descended from the
family of Latinus, and Iulus was invested with the office of high
priest, which remained a long while in his family. Livy, bk. 1, ch. 3.
—Virgil, Æneid, bk. 1, &c.――According to Dionysius of
Halicarnassus, bk. 1, ch. 15, &c., the son of Æneas by Lavinia was
also called Ascanius.――A river of Bithynia. Virgil, Georgics, bk. 3,
li. 270.
Asia, one of the three parts of the ancient world, separated from Europe
by the Tanais, the Euxine, Ægean, and Mediterranean seas. The Nile
and Egypt divide it from Africa. It received its name from Asia the
daughter of Oceanus. This part of the globe has given birth to many
of the greatest monarchies of the universe, and to the ancient
inhabitants of Asia we are indebted for most of the arts and sciences.
The soil is fruitful, and abounds with all the necessaries as well as
luxuries of life. Asia was divided into many different empires,
provinces, and states, of which the most conspicuous were the
Assyrian and Persian monarchies. The Assyrian monarchy, according
to Eusebius, lasted 1240 years, and according to Justin 1300 years,
down to the year of the world 4380. The empire of Persia existed 228
years, till the death of Darius III., whom Alexander the Great
conquered. The empire of the Medes lasted 259 years, according to
Eusebius, or less, according to others, till the reign of Astyages, who
was conquered by Cyrus the Great, who transferred the power from
the Medes, and founded the Persian monarchy. It was in Asia that the
military valour of the Macedonians, and the bold retreat of the
10,000 Greeks, were so conspicuously displayed. It is in that part of
the world that we are to look for the more visible progress of luxury,
despotism, sedition, effeminacy, and dissipation. Asia was generally
divided into Major and Minor. Asia Major was the most extensive,
and comprehended all the eastern parts; and Asia Minor was a large
country in the form of a peninsula, whose boundaries may be known
by drawing a line from the bay of Issus, in a northern direction, to the
eastern part of the Euxine sea. Asia Minor has been subject to many
revolutions. It was tributary to the Scythians for upwards of 1500
years, and was a long time in the power of the Lydians, Medes, &c.
The western parts of Asia Minor were the receptacle of all the
ancient emigrations from Greece, and it was totally peopled by
Grecian colonies. The Romans generally and indiscriminately called
Asia Minor by the name of Asia. Strabo.—Mela.—Justin.—Pliny.—
Tacitus, &c.――One of the Oceanides, who married Japetus, and
gave her name to one of the three divisions of the ancient globe.
Apollodorus, bk. 1, ch. 2.――One of the Nereides. Hyginus.――A
mountain of Laconia. Pausanias, bk. 3, ch. 24.
Asia Palus, a lake in Mysia. Virgil, Æneid, bk. 7, li. 701.
Asinius Gallus, son of Asinius Pollio the orator, married Vipsania, after
she had been divorced by Tiberius. This marriage gave rise to a
secret enmity between the emperor and Asinius, who starved himself
to death, either voluntarily, or by order of his imperial enemy. He had
six sons by his wife. He wrote a comparison between his father and
Cicero, in which he gave a decided superiority to the former. Tacitus
bks. 1 & 5, Annals.—Dio Cassius, bk. 58.—Pliny, bk. 7,
ltr. 4.――Marcellus, grandson of Asinius Pollio, was accused of
some misdemeanours, but acquitted, &c. Tacitus, bk. 14,
Annals.――Pollio, an excellent orator, poet, and historian, intimate
with Augustus. He triumphed over the Dalmatians, and wrote an
account of the wars of Cæsar and Pompey, in 17 books, besides
poems. He refused to answer some verses against him by Augustus,
“because,” said he, “you have the power to proscribe me, should my
answer prove offensive.” He died in the 80th year of his age, A.D. 4.
He was consul with Cnaeus Domitius Calvinus, A.U.C. 714. It is to
him that the fourth of Virgil’s Bucolics is inscribed. Quintilian.—
Suetonius, Cæsar, chs. 30 & 55.—Dio Cassius, bks. 37, 49, 55.—
Seneca, de Tranquilitate Animi & ltr. 100.—Pliny, bk. 7, ch. 30.—
Tacitus, bk. 6.—Paterculus, bk. 2.—Plutarch, Cæsar.――A
commander of Mauritania, under the first emperors, &c. Tacitus,
Histories, bk. 2.――An historian in the age of Pompey.――Another
in the third century.――Quadratus, a man who published the history
of Parthia, Greece, and Rome.
Asōpus, a river of Thessaly, falling into the bay of Malta at the north of
Thermopylæ. Strabo, bk. 8.――A river of Bœotia, rising near
Platæa, and flowing into the Euripus, after it has separated the
country of the Thebans and Platæans. Pausanias, bk. 9, ch. 4.――A
river of Asia, flowing into the Lycus, near Laodicea.――A river of
Peloponnesus, passing by Sicyon.――Another of Macedonia,
flowing near Heraclea. Strabo, &c.――A river of Phœnicia.――A
son of Neptune, who gave his name to a river of Peloponnesus. Three
of his daughters are particularly celebrated, Ægina, Salamis, and
Ismene. Apollodorus, bk. 1, ch. 9; bk. 3, ch. 12.—Pausanias, bk. 2,
ch. 12.
Aspa, a town of Parthia, now Ispahan, the capital of the Persian empire.
Aspamithres, a favourite eunuch of Xerxes, who conspired with
Artabanus to destroy the king and the royal family, &c. Ctesias.
Asparagium, a town near Dyrrhachium. Cæsar, Civil War, bk. 3, ch. 30.
Asterŏpe and Asteropēa, one of the Pleiades, who were beloved by the
gods and most illustrious heroes, and made constellations after
death.――A daughter of Pelias king of Iolchos, who assisted her
sisters to kill her father, whom Medea promised to restore to life. Her
grave was seen in Arcadia, in the time of Pausanias, bk. 8,
ch. 11.――A daughter of Deion by Diomede. Apollodorus,
bk. 1.――The wife of Æsacus. Apollodorus, bk. 3.
Asteropæus, a king of Pæonia, son of Pelegon. He assisted Priam in the
Trojan war, and was killed, after a brave resistance, by Achilles.
Homer, Iliad, bk. 17, &c.
Astræus, one of the Titans who made war against Jupiter.――A river of
Macedonia, near Thermæ. Ælian, Varia Historia, bk. 15, ch. 1.
Astŭra, a small river and village of Latium, where Antony’s soldiers cut
off Cicero’s head.
Astŭres, a people of Hispania Tarraconensis, who spent all their lives in
digging for mines of ore. Lucan, bk. 4, li. 298.—Silius Italicus, bk. 1,
li. 231.
Astyăges, a son of Cyaxares, was the last king of Media. He was father
to Mandane, whom he gave in marriage to Cambyses, an ignoble
person of Persia, because he was told by a dream that his daughter’s
son would dispossess him of his crown. From such a marriage he
hoped that none but mean and ignorant children could be raised; but
he was disappointed, and though he had exposed his daughter’s son
by the effects of a second dream, he was deprived of his crown by his
grandson, after a reign of 35 years. Astyages was very cruel and
oppressive; and Harpagus, one of his officers, whose son he had
wantonly murdered, encouraged Mandane’s son, who was called
Cyrus, to take up arms against his grandfather, and he conquered him
and took him prisoner, 559 B.C. Xenophon, in his Cyropædia, relates
a different story, and asserts that Cyrus and Astyages lived in the
most undisturbed friendship together. Justin, bk. 1, ch. 4, &c.—
Herodotus, bk. 1, chs. 74, 75, &c.――A grammarian who wrote a
commentary on Callimachus.――A man changed into a stone by
Medusa’s head. Ovid, Metamorphoses, bk. 5, fable 6.
Atarbĕchis, a town in one of the islands of the Delta, where Venus had a
temple.
Atas and Athas, a youth of wonderful velocity, who is said to have run
75 miles between noon and the evening. Martial, bk. 4, ltr. 19.—
Pliny, bk. 7.
Ate, the goddess of all evil, and daughter of Jupiter. She raised such
jealousy and sedition in heaven among the gods, that Jupiter dragged
her away by the hair, and banished her for ever from heaven, and sent
her to dwell on earth, where she incited mankind to wickedness, and
sowed commotions among them. Homer, Iliad, bk. 19. She is the
same as the Discord of the Latins.
Athēna, the name of Minerva among the Greeks; and also among the
Egyptians, before Cecrops had introduced the worship of the goddess
into Greece. Pausanias, bk. 1, ch. 2.
Athēnæ, a celebrated city of Attica, founded about 1556 years before the
christian era, by Cecrops and an Egyptian colony. It was called
Cecropia from its founder, and afterwards Athenæ in honour of
Minerva, who had obtained the right of giving it a name in
preference to Neptune. See: Minerva. It was governed by 17 kings in
the following order:—After a reign of 50 years, Cecrops was
succeeded by Cranaus, who began to reign 1506 B.C.; Amphictyon,
1497; Erichthonius, 1487; Pandion, 1437; Erichtheus, 1397;
Cecrops II., 1347; Pandion II., 1307; Ægeus, 1283; Theseus, 1235;
Menestheus, 1205; Demophoon, 1182; Oxyntes, 1149; Aphidas,
1137; Thymœtes, 1136; Melanthus, 1128; and Codrus, 1091, who
was killed after a reign of 21 years. The history of the 12 first of
these monarchs is mostly fabulous. After the death of Codrus the
monarchical power was abolished, and the state was governed by 13
perpetual, and 317 years after, by seven decennial, and lastly, B.C.
684, after an anarchy of three years, by annual magistrates, called
Archons. See: Archontes. Under this democracy, the Athenians
signalized themselves by their valour in the field, their munificence,
and the cultivation of the fine arts. They were deemed so powerful by
the Persians, that Xerxes, when he invaded Greece, chiefly directed
his arms against Athens, which he took and burnt. Their military
character was chiefly displayed in the battles of Marathon, of
Salamis, of Platæa, and of Mycale. After these immortal victories,
they rose in consequence and dignity, and they demanded the
superiority in the affairs of Greece. The town was rebuilt and
embellished by Themistocles, and a new and magnificent harbour
erected. Their success made them arrogant, and they raised
contentions among the neighbouring states, that they might
aggrandize themselves by their fall. The luxury and intemperance,
which had been long excluded from the city by the salutary laws of
their countrymen, Draco and Solon, crept by degrees among all ranks
of people, and soon after all Greece united to destroy that city, which
claimed a sovereign power over all the rest. The Peloponnesian war,
though at first a private quarrel, was soon fomented into a universal
war; and the arms of all the states of Peloponnesus [See:
Peloponnesiacum bellum] were directed against Athens, which, after
28 years of misfortunes and bloodshed, was totally ruined, the 24th
April, 404 years before the christian era, by Lysander. After this, the
Athenians were oppressed by 30 tyrants, and for a while laboured
under the weight of their own calamities. They recovered something
of their usual spirit in the age of Philip, and boldly opposed his
ambitious views; but their short-lived efforts were not of great
service to the interest of Greece, and they fell into the hands of the
Romans, B.C. 86. The Athenians have been admired in all ages for
their love of liberty, and for the great men that were born among
them; but favour there was attended with danger; and there are very
few instances in the history of Athens that can prove that the jealousy
and frenzy of the people did not persecute and disturb the peace of
the man who had fought their battles and exposed his life in the
defence of his country. Perhaps, not one single city in the world can
boast, in such a short space of time, of such a number of truly
illustrious citizens, equally celebrated for their humanity, their
learning, and their military abilities. The Romans, in the more
polished ages of their republic, sent their youths to finish their
education at Athens, and respected the learning, while they despised
the military character of the inhabitants. The reputation which the
Athenian schools had acquired under Socrates and Plato was
maintained by their degenerate and less learned successors; and they
flourished with diminished lustre, till an edict of emperor Justinian
suppressed, with the Roman consulship, the philosophical meetings
of the academy. It has been said by Plutarch that the good men whom
Athens produced were the most just and equitable in the world; but
that its bad citizens could not be surpassed in any age or country, for
their impiety, perfidiousness, or cruelties. Their criminals were
always put to death by drinking the juice of hemlock. The ancients,
to distinguish Athens in a more particular manner, called it Astu, one
of the eyes of Greece, the learned city, the school of the world, the
common patroness of Greece. The Athenians thought themselves the
most ancient nation of Greece, and supposed themselves the original
inhabitants of Attica, for which reason they were called ἀυτοχθονες,
produced from the same earth which they inhabited, γηγενες sons of
the earth, and τεττιγες grasshoppers. They sometimes wore golden
grasshoppers in their hair as badges of honour, to distinguish them
from other people of later origin and less noble extraction, because
those insects are supposed to be sprung from the ground. The number
of men able to bear arms at Athens in the reign of Cecrops was
computed at 20,000, and there appeared no considerable
augmentation in the more civilized age of Pericles; but in the time of
Demetrius Phalereus there were found 21,000 citizens, 10,000
foreigners, and 40,000 slaves. Among the numerous temples and
public edifices none was more celebrated than that of Minerva,
which, after being burnt by the Persians, was rebuilt by Pericles, with
the finest marble, and still exists a venerable monument of the hero’s
patriotism, and of the abilities of the architect. Cicero, Letters to
Atticus, Against Verres, &c.—Thucydides, bk. 1, &c.—Justin, bk. 2,
&c.—Diodorus, bk. 13, &c.—Ælian, Varia Historia.—Pliny, bk. 7,
ch. 56.—Xenophon, Memorabilia.—Plutarch, in vitis, &c.—Strabo,
bk. 9, &c.—Pausanias, bk. 1, &c.—Valerius Maximus.—Livy,
bk. 31, &c.—Cornelius Nepos, Miltiades, &c.—Polybius.—
Paterculus.
Athĕsis, now Adige, a river of Cisalpine Gaul, near the Po, falling into
the Adriatic sea. Virgil, Æneid, bk. 9, li. 680.