Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Econ 114 > Chapter 6 > Flashcards

Chapter 6 Flashcards

1
Q

What does the inflation rate measure?

A

The percentage change in the price level from the previous period.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

How is CPI calculated in numerical terms?

A

CPI = (Cost of basket in current year / Cost of basket in base year) × 100.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What is core inflation?

A

Core inflation measures underlying inflation trends, excluding volatile items like food and energy.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Why are CPI and GDP deflator sometimes different?

A

CPI includes imported goods; GDP deflator includes only domestically produced goods.

CPI uses a fixed basket; GDP deflator changes with the composition of GDP.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What are the components of the CPI basket?

A

Common components include housing, transportation, food, and other goods and services.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Define substitution bias in the context of CPI.

A

It occurs when consumers replace more expensive goods with cheaper substitutes, but CPI doesn’t account for this change.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

If a senior spends 20% of their income on healthcare and healthcare costs rise by 50%, how is their cost of living affected?

A

The senior’s cost of living increases by 10% (0.20 × 0.50).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Explain ‘unmeasured quality change’ in CPI.

A

When product quality improves, the real value of money increases, but CPI may not fully adjust for this improvement.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is indexation commonly used for?

A

Adjusting wages, pensions, and taxes to reflect changes in the cost of living.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is bracket creep?

A

When inflation increases nominal incomes, pushing taxpayers into higher tax brackets, raising their tax burden without real income growth.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

How do changes in the prices of imports affect CPI and GDP deflator?

A

CPI: Affected since imports are included in the consumer basket.

GDP deflator: Not affected as it includes only domestically produced goods and services.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

How does a 10% increase in chicken prices versus caviar prices affect CPI? Why?

A

Chicken affects CPI more because it constitutes a larger share of the average consumer’s basket.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What happens to borrowers and lenders if inflation is higher than expected?

A

Borrowers gain as they repay loans with less valuable dollars.

Lenders lose as the real interest rate is lower than expected.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

How is the real income calculated?

A

Real income = Nominal income × (Base year CPI / Current year CPI).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What are some shortcomings of using CPI to measure the cost of living?

A

Substitution bias.

Exclusion of new goods.

Difficulty in measuring quality improvements.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

If nominal GDP is $1,320 and real GDP is $980, what is the GDP deflator?

A

GDP deflator = (Nominal GDP / Real GDP) × 100 = (1320 / 980) × 100 = 134.7.

17
Q

How does the CPI overstate cost-of-living increases?

A

By not reflecting substitution, new goods, or quality changes accurately, it overestimates the impact of inflation on consumers.

18
Q

What happens when a domestic producer raises prices on exports?

A

GDP deflator rises.

CPI remains unaffected.

19
Q

Calculate the inflation rate if CPI in Year 1 = 100 and CPI in Year 2 = 150.

A

Inflation rate = [(150 - 100) / 100] × 100 = 50%.

20
Q

What does ‘real interest rate’ signify?

A

The rate of growth in purchasing power after adjusting for inflation.

21
Q

What is the main purpose of measuring the overall price level in the economy?

A

To compare dollar figures across different periods.

22
Q

What is the Consumer Price Index (CPI)?

A

A measure of the overall cost of goods and services bought by a typical consumer.

23
Q

What are the five steps to compute the CPI?

A

Determine the basket.

Find the prices of the goods in the basket.

Compute the basket’s cost at different times.

Choose a base year and compute the index.

Compute the inflation rate.

24
Q

What is the formula to calculate the inflation rate?

A

Inflation rate = [(CPI in current year - CPI in previous year) / CPI in previous year] × 100.

25
Q

Differentiate between nominal and real interest rates.

A

Nominal interest rate: The rate reported without adjusting for inflation.

Real interest rate: Nominal interest rate minus inflation rate.

26
Q

List the three problems that make CPI an imperfect measure of the cost of living.

A

Substitution bias: Consumers switch to cheaper alternatives, which CPI doesn’t reflect.

Introduction of new goods: CPI’s fixed basket may exclude new items, undervaluing consumer choice.

Unmeasured quality changes: Quality improvements or deteriorations may not be fully captured.

27
Q

What is ‘indexation’?

A

The automatic correction of a dollar amount for the effects of inflation by law or contract.

28
Q

How does CPI differ from the GDP deflator?

A

CPI: Reflects prices of goods and services bought by consumers, using a fixed basket.

GDP deflator: Reflects prices of all goods and services produced domestically, adjusting dynamically with production.

29
Q

If the nominal interest rate is 7% and inflation is 5%, what is the real interest rate?

A

Real interest rate = 7% - 5% = 2%.

30
Q

Why does CPI overstate inflation?

A

CPI assumes a fixed basket and doesn’t account for substitution, new goods, or quality changes, leading to overestimated cost increases.

31
Q

What happens if the price of a domestically produced good rises? How are CPI and GDP deflator affected?

A

CPI is affected if the good is in the consumer basket.

GDP deflator always reflects the price change as it includes all domestically produced goods.

32
Q

What is the formula for the Consumer Price Index (CPI)?

A

CPI = (Cost of basket in current year / Cost of basket in base year) × 100.

33
Q

How is the Inflation Rate calculated?

A

Inflation Rate = (CPI in current year - CPI in previous year) / CPI in previous year × 100.

34
Q

What is the formula to calculate Real Income?

A

Real Income = Nominal Income × (Base Year CPI / Current Year CPI).

35
Q

How do you adjust dollar values for inflation between two years?

A

Value in Year 2 Dollars = Value in Year 1 Dollars × (Price Level in Year 2 / Price Level in Year 1).

36
Q

What is the formula for the Real Interest Rate?

A

Real Interest Rate = Nominal Interest Rate - Inflation Rate.

37
Q

How do you calculate the GDP Deflator?

A

GDP Deflator = (Nominal GDP / Real GDP) × 100.

38
Q

How is the cost of the basket of goods calculated (used in CPI)?

A

Cost of Basket = ∑(Price of Good × Quantity of Good).

39
Q

How do you calculate the inflation rate if you know the CPI in two different years?

A

Inflation Rate = (CPI in Year 2 - CPI in Year 1) / CPI in Year 1 × 100.

Econ 114 (6 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2025 Bold Learning Solutions. Terms and Conditions