# Inflation and Price

Topics: Inflation, Price index, Interest rate Pages: 2 (303 words) Published: March 3, 2013
[i].In a simple economy, people consume only 2 goods, food and clothing. The market basket of goods used to compute the CPI has 50 units of food and 10 units of clothing.

| |food |clothing | |2002 price |\$4 |\$10 | |2003 price |\$6 |\$20 |

a.What are the percentage increases in the price of food and in the price of clothing? b.What is the percentage increase in the CPI?
c.Do these price changes affect all consumers to the same extent? Explain.

[ii].Which is likely to have the larger effect on the CPI, a 2 percent increase in food or a 3 percent increase in diamond rings? Explain.

[iii].List the three major problems in using the CPI as a measure of the cost of living.

[iv].Why does the GDP deflator give a different rate of inflation than does the CPI?

[v].Compute how much each of the following is worth in terms of today’s dollars using 177 as the price index for today. a.In 1926 the CPI was 17.7 and the price of a movie ticket was \$0.25 b.In 1932 the CPI was 13.1 and a cook earned \$15.00 a week c.In 1943 the CPI was 17.4 and a gallon of gas cost \$0.19

[vi].Jay and Joyce meet George, the banker, to work out the details of a mortgage. They all expect that inflation will be 2 percent over the term of the loan, and they agree on a nominal interest rate of 6 percent. As it turns out, the inflation rate is 5 percent over the term of the loan. a.What was the expected real interest rate?

b.What was the actual real interest rate?
c.Who benefited and who lost because of the unexpected inflation?

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