Chapter 8

Question 1

Price Index

Answer 1

A “sample” of all the prices in an economy –> a basket of goods

Question 2

CPI: Consumer Price Index

Answer 2

Cost of the basket in a given yr. / cost of the basket in the base yr * 100

CPI=100 : in the base yr.
CPI>100 : cost of living is higher than base yr.
CPI<100 : cost of living is lower than base yr.

Question 3

Substitution Bias

Answer 3

Actual buyers will change the quantities of goods/services bought based on price

If the CPI basket doesn’t reflect these substitutions, it will overstate the increase in the cost of living.

Question 4

Innovation bias

Answer 4

Improved products usually have higher prices due to higher quality

If the CPI doesn’t account for the introduction of these new products, it may understate the increase in living standards.

Question 5

Rate of change (%)

Answer 5

change/starting point *100
new-old/old *100

Question 6

Inflation rate

Answer 6

New CPI-Old CPI/ Old CPI *100

Question 7

Deflation

Answer 7

Negative Inflation
Real Value (yr. Y) = Nominal Value (yr. X) * (CPI yr.Y/ CPI yr.X)

Question 8

How to Index real values to adjust for inflation

Answer 8

Real Value= Nominal Value / Price Index

Question 9

Adjust to real or relative change

Answer 9

Real/relative change = nominal change - inflation rate

Question 10

Adjust to real interest

Answer 10

Real Interest = nominal interest - inflation rate

Question 11

Who benefits and who bears the cost of (unpredicted) inflation

Answer 11

Benefits: borrowers who pay back money that is worth less
Bearers: Lenders/savers who are paid back in the future when money is worth less

Question 12

How to adjust for differences in the cost of living across nations

Answer 12

PPP adjusted Value nation y = actual value nation x (PPP nation y / PPP nation x)