Question

I have the following problems:

Item Sneakers Manicures Quantity Price (2011) (2011) 2 $55 1 $35 Quantity (2012) 2 1 Price (2012) $60 $40 11) Consumers in a country buy only two goods, sneakers and manicures. The prices and quantities purchased by urban households are in the table above. The reference base year is 2011. For these data, the CPI for 2012 is A) 160. B) 100. C) 110. D) 145. 12) Consumers in a country buy only two goods, sneakers and manicures. The prices and quantities purchased by urban households are in the table above. The reference base year is 2011. For these data, the CPI for 2011 is A) 160. B) 145. C) 100. D) 3.

as well as:

--14) An example of the commodity substitution bias in the calculation of the CPI is a price increase in

A) turkey when the price of chicken doesn't rise..

B) new homes because people's incomes have increased.

C) a 2014 Toyota Camry versus a 2005 Honda Civic..

D) a GPS unit versus a AAA map book.

and

-- 24) Governments should promote education because education contributes to the nation's

A) economic growth potential.

B) protection of property rights.

C) employment.

D) free markets

Answer 1

QUESTION 11

CPI is calculated as:

$\frac{Price_1}{Price_0}*100$

where Price1 is the total cost of the commodity basket in 2012 and Price0 is the same for 2011 ( i.e. the base year)

The basket of goods consists of 2 items - sneakers and manicures.

Cost of basket of goods in 2011 :

Quantity of sneakers in 2011*Price of sneakers in 2011 + Quantity of manicures in 2011*Price of manicures in 2011

= 2*55 + 1*35 = 110+35 = $145

Cost of basket of goods in 2012:

Quantity of sneakers in 2012*Price of sneakers in 2012 + Quantity of manicures in 2012*Price of manicures in 2012

= 2*60+1*40 = 120 + 40 = $160

Hence, CPI for 2012 is :

$\frac{Price_1}{Price_0}*100$

$=\frac{160}{145}*100$

$=110.344$

= 110 (approx)

So the correct answer is option C

QUESTION 12

The CPI for 2011 is

$\frac{Price_0}{Price_0}*100$

where Price0 is the cost of the commodity basket for 2011.

Note that as we are finding the CPI of 2011 with respect to itself, which is the base year, the numerator and the denominator are the same.

Hence,

CPI for 2011 is

$=\frac{145}{145}*100$

=100

So the correct option is option C

QUESTION 14

Commodity substitution bias in the calculation of the CPI refers to the fact that while we calcuate the CPI to talk about the overall inflation and rise in the price of consumption basket, we don't take into consideration the existence of substitution effect. As a result the inflation is often biased upwards ( i.e. overestimated than what it actually is)

You see, when there is an increase in price in one of the goods, the consumers will inevitably look for the substitutes which are basically cheaper alternatives of the former. As a result, the effect on inflation would be lesser than what the estimates show.

Hence an example will be substituting from buying turkey to buying chicken when the price of chicken doesn't rise..

Hence option A is the answer.

QUESTION 24

Governments should promote education because education contributes to the nation's economic growth potential. Education will help develop human capital of the economy which translated to more and more skilled laborers. Skilled workforce means that the country is in a path of development and growth.

Hence option A is the answer.