c.22 problem sets

The table below shows the total expenditure on a basket of goods and services for consecutive years. Use this information to calculate the inflation rate for Years 2, 3, and 4 in that order. (Round your answers to two decimal points.)

(Expenditure in new year - Expenditure in previous year) / Expenditure in previous year × 100 = Inflation rate

The table below shows the index numbers for the cost of a basket of goods and services in each period. Use this information to calculate the inflation rate since the previous period. (Round to two decimal places and list your answers starting with Period 2.

(Index in new period - Index in previous period) / Index in previous period × 100 = Inflation rate

The table below shows the index numbers for the cost of a basket of goods and services in each period. Use this information to calculate the inflation rate in Period 2. (Round to two decimals.) period 1 = 133 period 2 = 146

146-133 / 133 x 100 = 9.77%

At the beginning of 2017, $1 had about the same purchasing power in overall terms of goods and services as ___________did in 1972.

18 cents

Which of the following statements is true? a. All companies can afford to provide of cost of living adjustments to their employees. b. Lenders only provide loans that adjust automatically with inflation. c. Social Security benefits are not protected against inflation. d. During inflationary periods, some politicians could becomes less opposed to indexing.

During inflationary periods, some politicians could becomes less opposed to indexing. • As partial inflation indexing spreads, the political opposition to inflation may diminish; because many sectors of the economy are in the practice of putting measures in place to protect themselves against inflation (and thus indexing) - making indexing less of a political concern.

True or false? The Employment Cost Index measures the cost of hiring new workers.

False By definition, the Employment Cost Index measures wage inflation in the labor market.

True or false? The arrival of new goods creates problems with respect to the accuracy of measuring inflation because new goods have always been immediately included in the inflation calculations.

False Government statisticians at the U.S. Bureau of Labor Statistics calculate the CPI based on the prices in a fixed basket of goods and services that represents the purchases of the average family of four. This leaves out new goods introduced in the market. By the early 2000s, the Bureau of Labor Statistics was using alternative mathematical methods for calculating the Consumer Price Index, more complicated than just adding up the cost of a fixed basket of goods, to allow for some substitution between goods. It was also updating the basket of goods behind the CPI more frequently, so that it could include new and improved goods more rapidly.

True or false? The Consumer Price Index (CPI) is a weighted average of the prices of all goods and services that are available in the U.S. economy.

False The Consumer Price Index is calculated by taking the 80,000 prices of individual products (not all products) and combining them, using weights determined by the quantities of these products that people buy, to impute the Consumer Price Index.

Which of the following statements is true about inflation?

Inflation redistributes purchasing power in the economy. • Inflation can cause redistributions of purchasing power that hurt some and help others. For example, people who are hurt by inflation include those who are holding considerable cash, while wages tend to creep up with inflation over time.

Which of the following is true about the International Price Index?

It is a measure of price level based on prices of merchandise that is exported or imported.

The inflation rate is most commonly derived from which of the following macroeconomics measures

The Consumer Price Index • In the United States, the Consumer Price Index (CPI) is the most commonly used index that is widely used to calculate inflation.

John borrows $50,000 from Bank of Xurbia at a fixed interest rate of 5%. If inflation is 5% at the time the loan is made, then:

The real interest rate on the loan is zero. • When interest rates are fixed, and the rate of inflation is equal to the interest rate, suppliers of financial capital, receive repayments that are exactly worth the cost to provide financial capital. That is, the real interest rate is zero.

Some economists argue that during an inflationary period, the erosion of real wages could help reduce the rate of inflation.

True Inflation would contribute to a decline in real wages which in turn reduces the purchasing power of households. If households respond to a reduction in a purchasing power by reducing their expenditure, this could have an effect of slowing down the inflation rate for prices levels could decline due a decrease in demand.

Loans that have _________________ have interest rates that vary with the rate of inflation.

adjustable rates • By definition, an adjustable rate mortgage (ARM) is a type of loan that one can use to purchase a home in which the interest rate varies with the rate of inflation. A fixed rate loan does not an interest rate that varies with inflation.

All of the following statements are true, except: a. A firm can make money from inflation by paying bills and wages as late as possible so that it can pay in inflated dollars, while collecting revenues as soon as possible. b. If a firm is currently holding a lot of assets in cash, it would benefit from inflation c. An economy with high inflation rewards businesses that have found clever ways of profiting from inflation. d. In the short term, low or moderate levels of inflation may not pose an overwhelming difficulty for business planning.

b. If a firm is currently holding a lot of assets in cash, it would benefit from inflation • If inflation declines more than anticipated, the purchasing power of cash increases. Therefore, in this case, the firm would benefit from increases in purchasing power.

Which of the following statements is true? a. If the price level (as measured by the CPI) increases, a borrower with an adjustable rate mortgage (ARM) will receive a lower interest rate. b. If the price level (as measured by the CPI) increases, a borrower with an adjustable rate mortgage (ARM) will receive a higher interest rate. c. If the price level (as measured by the CPI) increases, a borrower with a fixed-rate mortgage will receive a lower interest rate. d. If the price level (as measured by the CPI) increases, a borrower with a fixed-rate mortgage will receive a higher interest rate.

b. If the price level (as measured by the CPI) increases, a borrower with an adjustable rate mortgage (ARM) will receive a higher interest rate.

All of the following statements are true, except: a. Ordinary people can sometimes benefit from the unintended redistributions of inflation. b. When interest rates are fixed, rises in the rate of inflation tend to penalize suppliers of financial capital. c. When interest rates are fixed, demanders of financial capital typically end up worse off than suppliers of financial capital. d. The unintended redistributions of buying power that inflation causes can have a broad impact on society.

b. When interest rates are fixed, rises in the rate of inflation tend to penalize suppliers of financial capital.

All of the following statements are true, except: a. If inflation varies substantially over the short or medium term, then it may make sense for businesses to stick to shorter-term strategies. b. In recent decades in the U.S., rising inflation rates have at times been closely followed by lower inflation rates. c. In recent decades in the U.S, rising inflation rates have always corresponded to increasing productivity rates. d. There is some evidence that if inflation can be held to moderate levels, it doesn't prevent a nation's real economy from growing at a healthy pace.

c. In recent decades in the U.S, rising inflation rates have always corresponded to increasing productivity rates.

The substitution bias __________________.

helps explain why the CPI overestimates inflation • When the price of a good rises, consumers tend to purchase less of it and to seek out substitutes instead. This pattern implies that goods with generally rising prices should tend over time to become less important in the overall basket of goods used to calculate inflation, while goods with falling prices should tend to become more important. Thus, substitution bias—the rise in the price of a fixed basket of goods over time—tends to overstate the rise in a consumer's true cost of living, because it does not take into account that the person can substitute away from goods whose relative prices have risen.

The components with the highest weights in the Consumer Price Index are _____________.

housing, and food and beverage • Of the eight categories used to generate the Consumer Price Index, housing is the highest at 42.7%. The next highest category, food and beverage at 15.3%, is less than half the size of housing. Other goods and services, and apparel, are the lowest at 3.4% and 3.3%, respectively.

If the price index leaves out new goods, it overlooks one of the ways in which the cost of living is improving and ______________ the true cost of living.

overstates The quality/new goods bias means that the rise in the price of a fixed basket of goods over time tends to overstate the rise in a consumer's true cost of living, because it does not account for how improvements in the quality of existing goods or the invention of new goods improves the standard of living.

Which of the following are considered sources of bias in the CPI?

quality changes • Improvements in product quality creates problems with respect to the accuracy of measuring inflation. Thus, if the price index leaves out new better quality goods, it overlooks one of the ways in which the cost of living is improving.

Wages that have cost-of-living adjustments maintain their ___________________.

real value • Cost-of-living adjustments (COLAs) are meant to guarantee that wages would keep up with inflation, thus maintain the real value of wages.

Consider an individual who borrowed $10,000 to purchase a used car at a fixed interest rate of 7%. If inflation increases from 2% to 5%, how will this impact the real interest rate the individual will be paying?

the car loan must be repaid at a real interest rate of 2% • Ordinary people can sometimes benefit from the unintended redistributions of inflation. Consider someone who borrows $10,000 to buy a car at a fixed interest rate of 7%. If inflation is 5% at the time the loan is made, then he or she must repay the loan at a real interest rate of 2%. (7%−5%=2%)

Consider a family buys a new home with a home loan of $125,000 at a fixed interest rate of 7%. If inflation increases from 5% to 7%, how will this impact the real interest rate the individual will be paying?

the home loan must be repaid at a real interest rate of zero • The home loan's fixed interest rate of 7% will subtract the new inflation rate of 7% and the loan must be repaid at a real interest rate of zero. (7%−7%=0%)

In order to maintain purchasing power for those wage earners, the federal minimum wage rate should keep up with _________________.

the rate of inflation • When inflation happens, the buying power of fixed amount of money diminishes. If the federal minimum wage rate keeps up with inflation, the real minimum wage remains constant.

A purpose of the Core Inflation Index is _______________.

to be a gauge from which to make important government policy changes • Economists typically calculate a core inflation index by taking the CPI and excluding volatile economic variables. In this way, economists have a better sense of the underlying trends in prices that affect the cost of living. Both the CPI and the core inflation index are important, but serve different audiences. The CPI helps households understand their overall cost of living from month to month, while the core inflation index is a preferred gauge from which to make important government policy changes.

The table below shows a consumer's basket of goods and services in a given month. The price column reveals the price of each good or service and the quantity column reveals how many units of the good or service the consumer consumed in a given month. Using the information in the table, calculate the cost of this basket of goods and services for this consumer. good X = $8 → 10 good Y = $11 → 15 good Z = $15 → 8

total price = 8(10) + 11(15) + 15(8) = $365

Which of the following are examples of defined contribution plans?

• 401(k)s • 403(b)s 401(k)s and 403(b)s are examples of defined contribution plans. In these plans, the employer contributes a fixed amount to the worker's retirement account on a regular basis (usually every pay check). The employee often contributes as well. The worker invests these funds in a wide range of investment vehicles.

Retirement pension plans, also called "defined benefits" plans, traditionally are set as a fixed income per year at retirement. What are some characteristics of a pension plan?

• An inflation rate of just 1% to 2% per year can decrease the buying power on an individual's fixed income. • A pension does not keep up with inflation and buying power is lost over time.

Why is indexing not always considered the best answer to inflation?

• not every employer will provide COLAs for workers • not all companies can assume that costs and revenues will rise in lockstep with the general rates of inflation • not all interest rates for borrowers and savers will change to match inflation exactly