CHAPTER 24

MEASURING THE COST OF LIVING

1. According to the BLS’s inflation calculator, $100 in 2004

(when I was born) had the same value as $161.57 compare to
recent days (2023)
Based on information on the Internet:
CPI in February 2004: 186.2
CPI in February 2023: 300.840
Then the value of $100 in 2004 is equal to:
𝐶𝑃𝐼 𝑖𝑛 2023 300.840
$100 x 𝐶𝑃𝐼 𝑖𝑛 2004
= $100 x 186.2
= 161.56 (CPI in February)
2.
Cauliflower Broccoli Carrot

2016 $200 - 100 $75 - 50 bunches $50 - 500 carrots

heads

2017 $225 - 75 heads $120 - 80 bunches $100 - 500 carrots

a) The price of one unit of each vegetable in:
- 2016
$200
+ Cauliflower: 100
= $2
$75
+ Broccoli: 50
= $1.5
$50
+ Carrot: 500
= $0.1
- 2017
$225
+ Cauliflower: 75
= $3
$120
+ Broccoli: 80
= $1.5
$100
+ Carrot: 500
= $0.2
b) Using 2016 as the base year:
2016 200 + 75 + 50
- 𝐶𝑃𝐼 = 200 + 75 + 50
= 1
2017 225 + 120 + 100
- 𝐶𝑃𝐼 = 75×2 + 80×1.5 + 500×0.1
= 1.39
c) The inflation rate in 2017:
2017 2016
2017 𝐶𝑃𝐼 − 𝐶𝑃𝐼 1.39 − 1
π = 2016 × 100% = 1
× 100% = 39%
𝐶𝑃𝐼
3.
 a) The percentage change in the price of:
- Tennis Balls: unchanged
$6 − $4
- Golf Balls: increased: $4
x 100% = 50%
$2 − $1
- Bottles of Gatorade: increased: $1
x 100% = 100%
b) Choose the base year as 2017

Year Total cost of the basket CPI

2017 $2 × 100 + $4 × 100 + $1 × 100 = $700 100

2018 $2 × 100 + $6 × 100 + $2 × 200 = $1200 1200

× 100 = 171.43%
700

The percentage change in the overall price level:

171.43 − 100
100
× 100% = 71.43%
c) That information could affect the calculation of the
inflation rate. If I was to learn that a bottle of Gatorade
increased in size from 2017 to 2018, that would lower my
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 bottle
as the unit.
d) That information couldn’t affect the calculation of the
inflation rate. 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. See Section: Problems in
Measuring the Cost of Living.
4. According to the data on the CPI from the website of the
BLV(https://www.bls.gov/news.release/cpi.nr0.htm):
- The all items index increased 6.0 percent for the 12 months
ending February
- The index for shelter was the largest contributor to the
monthly all items increase, accounting for over 70 percent of
the increase, with the indexes for food, recreation, and
household furnishings and operations also contributing.
5.
 a) Using a method similar to the CPI, compute the
percentage change in the overall price level.Use 2017 as
the base year and fix the basket at 1 karaoke machine
and 3 CDs.
Year Total cost of the CPI
basket (1 karaoke
machine, 3 CDs)

2017 (base year) $40 × 1 + $10 × 3 = $70 70

× 100 = 100
70

2018 $60 × 1 + $12 × 3 = $ 96 96

× 100 = 137
70

The percentage change in total price (CPI):

137 − 100
100
× 100% = 37%
b) Using a method similar to the GDP deflator, compute the
percentage change in the overall price level. Also use
2017 as the base year.

Year Nominal GDP Real GDP GDP deflator

2017 40 × 10 + 10 × 30 = 700 40 × 10 + 10 × 30 = 700 700

× 100 = 100
700

2018 60 × 12 + 12 × 50 = 1320 40 × 12 + 10 × 50 = 980 1320

× 100 = 135
980

The percentage change in the overall price level:

135−100
100
× 100% = 35%
c) The inflation rate is lower in 𝐺𝐷𝑃𝑑 since it includes
all aspects of the economy while CPI focuses on one
specific bundle of goods.
6. The problems in the construction of the CPI might be
illustrated by
a) The invention of cell phones: New item
b) The introduction of air bags in cars: Quality improvement
c) Increased personal computer in response to a decline in
price: Substitution for more expensive stuff
d) More scoops of raisins in each package: Quality increase
e) Greater use of fuel efficient cars after gas price increase:
Substitution
7. A dozen eggs cost $0.88 in January 1980 and $2.11 in January
2015. The average wage for production workers was $7.58 per hour
in January 1980 and $19.64 in January 2015.
a) The price of eggs rise:
2.11 − 0.88
0.88
× 100% = 139. 78%
b) The wage rise:
 19.64 − 7.58
7.58
× 100% = 159. 1%
c) To earn enough to by a dozen eggs a worker have to work:
0.88×60
- 1980: 7.58
= 6. 96 (minutes)
2.11×60
- 2015: 19.64
= 6. 45 (minutes)
d) Workers’purchasing power in terms of eggs rise as they have
to work shorter to buy a dozen 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, 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) 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, we would need to put together
a market basket for the elderly that would have a higher
weight on healthcare 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) When inflation is lower than expected, the real interest rate
is higher than expected. For example, suppose the market
equilibrium has an expected real interest rate of 3% and
people expect inflation to be 4%, so the nominal interest
rate is 7%. If inflation turns out to be 3%, the real
interest rate is 7%−3%=4% , which is higher than the 3% that
was expected.
b) Because the real interest rate is higher than expected, the
lender gains and the borrower loses. The borrower is repaying
the loan with dollars that are worth more than expected
c) Homeowners in the 1970s who had fixed-rate mortgages from the
1960s benefited (with regard to their mortgages) from the
unexpected higher inflation, since they were paying off their
loans in dollars whose real value had declined, while the
banks that made the mortgage loans were harmed.