Question

06 Suppose that a typical urban family purchases only two goods, whose prices and typical consumption quantities are as follows: Fruit (lbs) Nuts (lbs) Prices in 2010 $2 $2 Quantity in 2010 200 200 Prices in 2011 S2 5 3 annt xloo Quantity in 2011 220 150 bare a. Using the year 2010 as the base year for calculations and also as the year for measuring the typical consumer's market basket, calculate the CPIs in 2010 and in 2011 (2pts). b. Compute the rate of inflation in 2011 (1 pt). c. Do you think your answer in b would understate the actual inflation rate in 2011? Why or why not? Show the evidence by using the above table (2pts). 07. (Extra credits: 3pts). What potential biases exist in calculating the CPI (list at least three)? What steps has the Bureau of Labor Statistics taken to reduce the size of the biases (at least one)?

need help w / question 6 (a,b,c) tysm!!!

Answer 1

Item	2010		2011
	Quantity (lbs)	Price ($/lbs)	Quantity (lbs)	Price ($/lbs)
Fruits	200	2	220	2
Nuts	200	2	150	3

Given that, 2010 is considered as the base year for calculating CPI and typical consumer basket

Price of the basket of goods in 2010 = Quantity of fruits in 2010 x Price of fruits in 2010 + Quantity of nuts in 2010 x Price of nuts in 2010 = 200 x $2 + 200 x $2 = $400 + $400 = $800

Price of the basket of goods in 2011 = Quantity of fruits in 2010 x Price of fruits in 2011 + Quantity of nuts in 2010 x Price of nuts in 2011 = 200 x $2 + 200 x $3 = $400 + $600 = $1000

a. CPI in 2010 = 100 (Since it is the base year)

CPI in 2011 = Price of the basket of goods in 20111/Price of the basket of goods in the base year(2010) x 100 = ($1000/$800) x 100 = 1.25 x 100 = 125

b. Rate of inflation in 2011 = [(CPI in 2011 - CPI in 2010)/CPI in 2010] x 100 = [(125-100)/100] x 100 = [25/100] x 100 = 25%

c. The inflation measured in the year 2011 would not understate the value of inflation. In fact, it is overstating inflation. This is because the quantity of nuts in the consumer basket is 200 lbs which is more than the actual consumption of 150 lbs in the year 2011. Another measure of inflation can be obtained by using GDP deflator which takes into account all the goods in the amounts produced in the year and compares it at constant dollars with the previous year

GDP deflator = Nominal GDP/Real GDP x 100

Nominal GDP in 2011= Quantity of fruits in 2011 x Price of fruits in 2011 + Quantity of nuts in 2011 x Price of nuts in 2011 = 220 x $2 + 150 x $3 = $440 + $450 = $890

Real GDP in 2011 = Quantity of fruits in 2011 x Price of fruits in 2010 + Quantity of nuts in 2011 x Price of nuts in 2010 = 220 x $2 + 150 x $2 = $440 + $300 = $740

GDP Deflator for 2011 = $890/$740 x 100 = 120.27%

GDP Deflator for 2010 = 100 (base year)

Inflation rate calculated using GDP deflator = (GDP deflator in 2011 - GDP deflator in 2010)/GDP deflator in 2010 x 100 = (120.27 - 100)/100 x 100 = 20.27% (which is less than the inflationn rate calculated using CPI)

Inflation rate calculated from GDP deflator shows that the inflation calculated using CPI is overstated.