CHAPTER 24: MEASURING THE COST OF LIVING

TEST
1. The consumer price index is used to
a. convert nominal GDP into real GDP.
b. turn dollar figures into meaningful measures of purchasing power.
c. characterize the types of goods and services that consumers purchase.
d. measure the quantity of goods and services that the economy produces.

2. Economists use the term inflation to describe a situation in which

a. some prices are rising faster than others.
b. the economy's overall price level is rising.
c. the economy's overall price level is high, but not necessarily rising.
d. the economy's overall output of goods and services is rising faster than the
economy's overall price level.

3. The inflation rate is defined as the

a. price level in an economy.
b. change in the price level from one period to the next.
c. percentage change in the price level from the previous period.
d. price level minus the price level from the previous period.

4. The inflation rate you are likely to hear on the nightly news is calculated
from
a. the GDP deflator.
b. the CPI.
c. the VN-INDEX
d. the unemployment rate.

5. The CPI is more commonly used as a gauge of inflation than the GDP
deflator is because
a. the CPI is easier to measure.
b. the CPI is calculated more often than the GDP deflator is.
c. the CPI better reflects the goods and services bought by consumers.
d. the GDP deflator cannot be used to gauge inflation.

6. The CPI is a measure of the overall cost of the goods and services bought
by
a. a typical consumer, and the CPI is computed and reported by the Ministry of
Industry and Trade.
b. typical consumers and typical business firms, and the CPI is computed and
reported by the Ministry of Industry and Trade.
c. a typical consumer, and the CPI is computed and reported by the General
Statistics Office.
d. typical consumers and typical business firms, and the CPI is computed and
reported by the General Statistics Office.

7. The CPI is calculated

a. weekly.
b. monthly.
c. quarterly.
d. yearly.

8. The steps involved in calculating the consumer price index and the
inflation rate, in order, are as follows:
a. Choose a base year, update the basket, find the prices, estimate the basket’s
cost, compute the index, and compute the inflation rate.
b. Choose a base year, fix the basket, find the prices, compute the inflation rate,
compute the basket's cost, and compute the index.
c. Fix the basket, find the prices, compute the basket's cost, choose a base year
and compute the index, and compute the inflation rate.
d. Fix the basket, find the prices, compute the inflation rate, compute the
basket’s cost, and choose a base year and compute the index.

9. When computing the cost of the basket of goods and services purchased
by a typical consumer, which of the following changes from year to year?
a. the quantities of the goods and services purchased
b. the prices of the goods and services
c. the goods and services making up the basket
d. All of the above are correct.

10. In computing the consumer price index, a base year is chosen. Which of
the following statements about the base year is correct?
a. The base year is always the first year among the years for which
computations are being made.
b. It is necessary to designate a base year only in the simplest case of two
goods; in more realistic cases, it is not necessary to designate a base year.
c. The value of the consumer price index is always 100 in the base year.
d. The base year is always the year in which the cost of the basket was highest
among the years for which computations are being made.

11. If the consumer price index was 96 in 2012, 100 in 2013, and 102 in
2014, then the base year must be
a. 2012.
b. 2013.
c. 2014.
d. The base year cannot be determined from the given information.

12. Suppose a basket of goods and services has been selected to calculate
the CPI and 2012 has been chosen as the base year. In 2012, the basket’s
cost was $80.00; in 2013, the basket’s cost was $84; and in 2014, the
basket’s cost was $87.60. The value of the CPI was
a. 100 in 2012.
b. 105 in 2013.
c. 109.5 in 2014.
d. All of the above are correct.

Solution:
13. The inflation rate is the
a. absolute change in real GDP from one period to another.
b. percentage change in real GDP from one period to another.
c. absolute change in the price level from one period to another.
d. percentage change in the price level from one period to another.

14. Because consumers can sometimes substitute cheaper goods for those
that have risen in price,
a. the CPI overstates inflation.
b. the CPI understates inflation.
c. the GDP deflator overstates inflation.
d. the GDP deflator understates inflation.

15. Suppose a basket of goods and services has been selected to calculate
the CPI and 2002 has been selected as the base year. In 2002, the basket’s
cost was $50; in 2004, the basket’s cost was $52; and in 2006, the basket’s
cost was $57.25. The value of the CPI in 2006 was
a. 91.6.
b. 104.6.
c. 109.2.
d. 114.5.

Solution:
 16. In an imaginary economy, consumers buy only hot dogs and
hamburgers. The fixed basket consists of 10 hot dogs and 6 hamburgers.
A hot dog cost $3 in 2006 and $5.40 in 2007. A hamburger cost $5 in 2006
and $6 in 2007. Which of the following statements is correct?
a. When 2006 is chosen as the base year, the consumer price index is 90 in
2007.
b. When 2006 is chosen as the base year, the inflation rate is 150 percent in
2007.
c. When 2007 is chosen as the base year, the consumer price index is 100 in
2006.
d. When 2007 -> 2006? is chosen as the base year, the inflation rate is 50
percent in 2007.

Solution:
1. Calculate the total cost of the basket in 2006 and 2007:
 In 2006:
o Cost of 10 hot dogs = $3/hotdog * 10 hotdogs = $30
o Cost of 6 hamburgers = $5/hamburger * 6 hamburgers = $30
o Total cost of the basket in 2006 = $30 + $30 = $60
 In 2007:
o Cost of 10 hot dogs = $5.40/hotdog * 10 hotdogs = $54
o Cost of 6 hamburgers = $6/hamburger * 6 hamburgers = $36
o Total cost of the basket in 2007 = $54 + $36 = $90
2. Apply the CPI formula (Laspeyres Index):
CPI = (Cost of basket in current year / Cost of basket in base year) * 100
CPI (2007) = ($90 / $60) * 100 = 150

17. During a certain year, the consumer price index increased from 120 to
132 and the purchasing power of a person’s bank account increased by 4
percent. For that year,
a. the nominal interest rate was 6 percent.
b. the nominal interest rate was 14 percent.
c. the inflation rate was 12 percent.
d. the inflation rate was 9 percent.

Solution:
18. Rosa deposits $100 in a bank account that pays an annual interest rate
of 20 percent. A year later, after Rosa has accumulated $20 in interest, she
withdraws her $120. Rosa’s purchasing power
a. did not change if the inflation rate was 20 percent.
b. decreased if the inflation rate was -5 percent.
c. increased if the inflation rate was 22 percent.
d. More than one of the above is correct.

19. A worker received $5 for a daily wage in 1930, which has the equivalent
value of $63.24 today. If the CPI was 17 in 1930 what is the value of the
CPI today, rounded to the nearest whole number?
a. 215
b. 134
c. 17
d. 1.3

Solution:
20. The consumer price index was 200 in 2012 and 208 in 2013. The
nominal interest rate during this period was 9 percent. What was the real
interest rate during this period?
a. 5.00 percent
b. 1.00 percent
c. 5.15 percent
d. 13.00 percent

Solution: