Question

In a fictional country, Hobbiton, there are only three commodities are produced and sold: honey-cake, tunic, and mulled cider. In 2018 and 2019, prices of these items were as follows: Year 2018 2019 Honey-cake $8 $12 Mulled cider $3 $2 Tunic $30 $50 Suppose a typical consumer in Hobbiton annually consumes 500 honey-cakes, 1000 mulled cider, and 100 tunics. (In other words, the consumer price index (CPI) basket consists of 500 honey-cakes, 1000 mulled cider, and 100 tunics.) Calculate CPI of each year for this economy. Use 2018 as the base year. • CPI (2018): 12000 • CPI (2019): 13000 Calculate the inflation rate between 2018 and 2019, using CPI. • Inflation rate (2018-2019): 8.33

Answer 1

Q1.

Given,

Composition of the CPI basket: 500 honey-cakes, 1000 mulled cider & 100 tunics

Base year = 2018

Cost of the basket of goods in 2018 = Price of honey-cake in 2018*500 + Price of mulled cider in 2018*1,000 + Price of tunics in 2018*100 = $8*500 + $3*1,000 + $30*100 = $10,000

CPI(2018) = 100 (As 2018 is the base year)

Cost of the basket of goods in 2019 = Price of honey-cake in 2019*500 + Price of mulled cider in 2019*1,000 + Price of tunics in 2019*100 = $12*500 + $2*1,000 + $50*100 = $13,000

CPI(2019) = [Cost of the basket of goods in 2019/Cost of the basket of goods in 2018(base year)] * 100 = [$13,000/$10,000] * 100 = 130

Inflation rate(2018-2019) = [(CPI(2019) - CPI(2018))/CPI(2018)] * 100 = [(130-100)/100] * 100 = 30%

Q2.

a) Price level last year = 100

Price level this year = 110

Inflation rate = [(Price level this year - Price level last year)/Price level last year] * 100 = [(110-100)/100]*100 = 10%

b)

Price level last year = 250

Price level this year = 300

Inflation rate = [(Price level this year - Price level last year)/Price level last year] * 100 = [(300-250)/250] * 100 = 20%

c)

Price level last year = 4,000

Price level this year = 4,000

Inflation rate = [(Price level this year - Price level last year)/Price level last year] * 100 = [(4,000-4,000)/4,000]*100 = 0%