Question

Abby consumes only apples. In year 1, red apples cost $1 each, green apples cost $2 each, and Abby buys 10 red apples. In year 2, red apples cost $2 each, green apples cost $1 each, and Abby buys 10 green apples. Assume that year 1 is the base vear in which the consumer basket is fixed a. Compute the CPI for apples for each year. Assume that year 1 is the base year in which the consumer basket is fixed How does your index change from year 1 to year 2? The CPI for year 1 is: 100 The CPI for yea 2 is: 100 CPI hasstayed the same b. Compute Abby's nominal spending on apples in each year. How does it change from year 1 to year 2? Nominal Spending in year: S 10 Nominal spending in year 2: 10 Nominal spending has stayed the same. c. Using year 1 as the base year, compute Abby's real spending on apples in each year. How does it change from year 1 to year 2? Real spending in year 1: S 10 Real spending in year 2: $ 10 Real spending hasstayed the same

Need help, please show work. Options for each blank are (doubles, stayed the same, or fallen by half). EXCEPT, the options for the blank at E are (increased, decreased, or stays the same).

Answers marked in red are incorrect.

Answer 1

	Year 1		Year 2		market basket in Year 1 Price in year 1 x Quantity in year 1	market basket in Year 2 Price in year 2 x Quantity in year 1	Nominal spending in Year 1 (Price in year 1 * quantity in year 1)	Nominal spending in Year 2 (Price in year 2 * quantity in year 2)
Item	Price $	Quantity	Price $	Quantity
Red apples	1	10	2	0	10	20	10	0
Green apples	2	0	1	10	0	0	0	10
					10	20	10	10
CPI for year 2=( Cost of the base year market basket in the current period (year 1)/Cost of the base year market basket in the base period (year 2)x100
(20/10)*100=200
a
CPI for year 1 (base year) is 100
CPI for year 2 is 200
CPI has doubled.
b
$10
$10
same
c)
Real spending is current year quantity x base year price.
year 1 nominal and real GDP is same. So real spending is $10.
Year 2. Real spending is
(Price of red apples in year 1 + Quantity of red apples in year 1)+ (price of green apples in year 1 + quantity of green apples in year2)
($1 x 0) + ($2 x10)
0 + $20= $20.
Doubled.
d)
Deflator= Nominal spending/Real spending
Deflator in base year is always 100.
Deflator in year 2=$10/$20=0.5.
Halved.
e) CPI has doubled from 100 in year 1 to 200 in year 2.
Deflator has fallen by half.
If both green and red apples are perfect substitutes, true cost of living has remained the same.