Chapter 11 Measuring the Cost of Living
An economy produces only two goods, oranges and VCRs. The quantities and prices for the years 2005 and 2006 are shown in the table. The base year is 2005.
2005 price oranges VCRs
2006 price
quantity $2
quantity
$3
4,000
5,000
$400 1,000 $300 2,000
1. The GDP deflator in 2006 is about ( D )
a. 76. b. 67. c. 51. d. 132.
2. The growth rate of nominal GDP in 2006 was about ( C )
a. 10%. b. 49%. c. 78%. d. 100%.
3. The growth rate of real GDP in 2006 was about ( C )
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a. 24%. b. 50%. c. 97%. d. 125%.
4. The rate of inflation in 2006 was about ( B )
a. –48%. b. –24%. c. 33%. d. 67%.
5. Which price index measures the average price of things purchased by the typical family in an urban area? ( C )
a. GDP deflator.
b. Producer Price Index.
c. Consumer Price Index.
d. Minimum Wage.
6. Which item would receive the most weight in the consumer price index? ( D )
a. Salt. b. Toothpicks. c. Pencils. d. Food.
7. The good that receives the most weight in the CPI is the good that ( D )
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a. consumers buy most frequently.
b. has experienced the greatest price increase.
c. has the highest price.
d. consumers spend the largest fraction of their income on.
8. Which of the following is a reason why the Consumer Price Index (CPI) is not calculated as a simple average of all prices? ( A )
a. Some goods experience large price changes and the CPI would be too variable if computed by a simple average.
b. Goods differ in their importance in the average consumer’s budget.
c. Some goods never experience price changes and the CPI would not be variable enough if computed as a simple average.
d. It would be difficult to compute a price index using a simple average of all prices.
9. If the price of the market basket of goods in the base year of 1994 was $20,000 and the price of the same basket had risen to $22,000 by 1998, the CPI
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for 1998 ( D )
a. cannot be calculated. c. is 200.
b. is $12,000. d. is 110.
10. Suppose you spend 30 percent of your budget on food, 20 percent on medical care, 40 percent on rent, 5 percent on entertainment, and 5 percent on miscellaneous items. If the price of all parts of your budget rise equally in percentage terms, which would have the most weight on your cost of living increase? (Assume you calculate your index the same way the CPI is calculated.) ( A )
a. Food. c. Rent.
b. Medical care. d. Entertainment.
11. Substitution bias ( A )
a. is one factor that causes the CPI to underestimate the inflation rate.
b. is caused by the poor quality of many imported products.
c. is one of the primary causes of inflation.
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d. involves consumer behavior that helps explain why the CPI overestimates the inflation rate.
12. Improvements in the quality of consumer goods and services over time ( D )
a. cause the CPI to overstate actual inflation.
b. cause the CPI to understate actual inflation.
c. are accounted for in the CPI.
d. are insignificant and thus would not affect the CPI even if accounted for.
13. The CPI differs from the GDP deflator in that the CPI ( D )
a. includes raw material prices whereas the GDP deflator does not.
b. includes only goods whereas the GDP deflator includes both goods and services.
c. includes only services whereas the GDP deflator includes both goods and services.
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d. includes only items the typical household buys, whereas the GDP deflator includes all goods and services produced in the economy.
14. The GDP deflator differs from the CPI because the GDP deflator includes goods we _______, while the CPI includes goods we ________. ( B )
a. import; export
b. export; import
c. buy; sell
d. consume; produce
15. If the consumer price index has a value of 150 today and the base year is 1987, then consumer prices have ( A )
a. increased by 50 percent since 1987.
b. doubled since 1987.
c. more than doubled since 1987.
d. declined 50 percent since 1987.
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16. Use this table to find the real wage in 2002. ( B )
YEAR NOMINAL WAGE ($/hour) CPI
2001 $12.50 155.0
2002 $13.00 160.0
a. $8.06
b. $8.13
c. $13.00
d. $20.80
17. If a lender wants a real return of 6 percent and she expects inflation to be 4 percent, which of the following is the nominal interest rate to charge? ( A )
a. 4 percent. b. 6 percent. c. 2 percent. d. 10 percent.
18. When borrowing money to purchase an automobile, Wei has the choice between a fixed nominal interest rate or adjustable nominal interest rate loan. Typically the adjustable rate loans start with a lower rate than the fixed rate loans.
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Given that, Wei would most likely want to borrow money at the higher fixed rate when she expects the ( A )
a. inflation rate to rise.
b. inflation rate to fall.
c. inflation rate to remain unchanged.
d. government to take action to lower the inflation rate in the near future.
19. If you borrow money at a nominal interest rate of 5 percent and the inflation rate is 10 percent, what real interest rate will you pay? ( C )
a. –5 percent.
b. 5 percent.
c. 2 percent.
d. 10 percent.
20. When the inflation rate ends up being lower than expected, ( D )
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a. everyone benefits because money is cheaper.
b. everyone benefits because price do not increase.
c. lenders of fixed-rate mortgages generally benefit because they will make higher profits than they had calculated.
d. borrowers with fixed-rate loans will benefit because their purchasing power will not decline as much.
21. In general, a higher-than-anticipated inflation rate ( C )
a. helps everyone.
b. hurts everyone.
c. helps creditors and harms debtors.
d. helps debtors and harms creditors.
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