Question

Suppose that people consume only three goods, as shown in this table: Tennis Balls Golf Balls Bottles of Gatorade 2017 $2 $4 $1 Quantity 100 100 200 2018 Price $2 $6 $2 Quantity 100 100 200

If you were to learn that a bottle of Gatorade increased in size from 2017 to 2018, that information would (raise, lower)your estimation of the inflation rate.

If you were to learn that Gatorade introduced new flavors in 2018, that would imply that the inflation rate you estimated is

(overstated, understated).

Answer 1

1. Calculating % change.

a) % change of tennis balls = [ (2/2) - 1 ] * 100

= 0%

b) % change of golf balls = [ (6/4) - 1 ] * 100

= 50%

c) % change of bottles of gatorade = [ (2/1) - 1 ] * 100

= 100%

2. Calculating % change in overall price levels.

Now, output in 2017 at 2017 prices.
= $2x100 + $4x100 + $1x200

= $200+ $400+ $200

= $800

output in 2018 at 2018 prices.

= $2x100 + $6x100 + $2x200

= $200+ $600+ $400

= $1,200

Therefore, % Change in overall price levels = ((1'200/800) - 1) * 100 = 50%

3. If the size of the bottle of gatorade is increased in year 2018 as compared to 2017, it means the amount of fluid also increses, therefore this information will lower. our estimation of inflation rate.

4. It means the inflation rate we estimated is overstated, because it is not only price rise, but also the rise in the utility of the product.