Question

Which group of people is harmed by the redistribution of purchasing power due to unexpected inflation?

a. home buyers with adjustable rate mortgages

b. students with variable-rate educational loans

c. Lenders

Which of the following is NOT a shortcoming of using the CPI to measure changes in the cost of living.

a. Substitution bias

b. Quality improvements

c. Monetary policy

Answer 1

1. (c) Unexpected inflation  occurs when people do not know what will be the inflation until the general price level increases. So lenders are the ones whose income majorly affected by the redistribution of purchasing power due to unexpected inflation. Lenders if receive there money back from debtors after the inflation, will have less worth in terms of purchasing power. General they lend the money to debtors at a fixed interest rate. Home buyers and students with variable-rate educational loans can adjust there rate after the real inflation is out through general price level increase, which is not possible for the lenders.

2). CPI or any other price index has some shortcomings. They does not factor in the changes in quality of any good being purchased by a household other economic agent. Generally when price of a commodity increases, it benefits to producers and loss to consumers, but in some cases consumers may benefit from purchasing a product whose price has increased as a result of improvement in quality of product or the purpose it serves.

CPI also does not include the substitution factor. CPI is calculated assuming that consumers continue to buy same amount of increasingly expensive goods .

So the left over from the options above , which is not a shortcoming of CPI, to measure changes in the cost of living is monetary policy. CPI is one of target instrument of monetary policy used to check various problems of an economy.