MacEcon Ch 9 Self-Check and Review Questions

Go to this website (http://www.measuringworth.com/ppowerus/) for the Purchasing Power Calculator at MeasuringWorth.com. How much money would it take today to purchase what one dollar would have bought in the year of your birth?

In 2018, the relative values of $1.00 from 2000 ranges from $1.41 to $2.00.

Compute the inflation rate for fruit prices from 2001 to 2004.

.The inflation rate is calculated as the percentage change in the price index from year to year. For example, the inflation rate between 2001 and 2002 is (84.61 - 69.71) / 69.71 = 0.2137 = 21.37%. The inflation rates for all the years are shown in the last row of the following table, which includes the two previous answers.

A fixed-rate mortgage has the same interest rate over the life of the loan, whether the mortgage is for 15 or 30 years. By contrast, an adjustable-rate mortgage changes with market interest rates over the life of the mortgage. If inflation falls unexpectedly by 3%, what would likely happen to a homeowner with an adjustable-rate mortgage?

Because the mortgage has an adjustable rate, the rate should fall by 3%, the same as inflation, to keep the real interest rate the same.

Edna is living in a retirement home where most of her needs are taken care of, but she has some discretionary spending. Based on the basket of goods in Table 9.5, by what percentage does Edna's cost of living increase between time 1 and time 2?

Begin by calculating the total cost of buying the basket in each time period, as shown in the following table. Items Quantity (Time 1) Price (Time 1) Total Cost (Time 2) Price (Time 2) Total Cost Gifts 12 $50 $600 $60 $720 Pizza 24 $15 $360 $16 $384 Blouses 6 $60 $360 $50 $300 Trips 2 $400 $800 $420 $840 Total Cost $2,120 $2,244

Identify several parties likely to be helped and hurt by inflation.

Borrowers and employers paying wages determined by long-term contracts are helped by inflation, but lenders and consumers are hurt.

How is a basket of goods and services used to measure the price level?

By selecting a basket of specific goods to track prices, we are able to get a more accurate representation of the costs faced by different groups of consumers or producers.

What is deflation?

Deflation is a generally lowering of prices, or a rise in the value of a currency.

How should an increase in inflation affect the interest rate on an adjustable-rate mortgage?

Higher inflation reduces real interest rates on fixed rate mortgages. Because ARMs can be adjusted, higher inflation leads to higher interest rates on ARMs.

Construct the price index for a "fruit basket" in each year using 2003 as the base year.

If 2003 is the base year, then the index number has a value of 100 in 2003. To transform the cost of a fruit basket each year, we divide each year's value by $15.35, the value of the base year, and then multiply the result by 100. The price index is shown in the following table. 2001 2002 2003 2004 69.71 89.90 100.00 106.3 Note that the base year has a value of 100; years before the base year have values less than 100; and years after have values more than 100.

Why are index numbers used to measure the price level rather than dollar value of goods?

Index numbers are easier to compare to one another, as the value of a dollar will change over time.

What is indexing?

Indexing is when some rate of payment is set to increase automatically at the same pace as inflation.

What has been a typical range of inflation in the U.S. economy in the last decade or so?

Inflation in the last decade, as measured by CPI, has typically been between 1% and 3%.

Name several forms of indexing in the private and public sector.

Most government benefits, such as Social Security, are indexed to CPI, and lately there has been a lot of discussion of doing the same thing for minimum wages.

How to Measure Changes in the Cost of Living introduced a number of different price indices. Which price index would be best to use to adjust your paycheck for inflation?

Since the CPI measures the prices of the goods and services purchased by the typical urban consumer, it measures the prices of things that people buy with their paycheck. For that reason, the CPI would be the best price index to use for this purpose.

The Consumer Price Index is subject to the substitution bias and the quality/new goods bias. Are the Producer Price Index and the GDP Deflator also subject to these biases? Why or why not?

The PPI is subject to those biases for essentially the same reasons as the CPI is. The GDP deflator picks up prices of what is actually purchased that year, so there are no biases. That is the advantage of using the GDP deflator over the CPI.

Over the last century, during what periods was the U.S. inflation rate highest and lowest?

The U.S. inflation rate was highest during the 1970s and lowest during the 1930s, when deflation actually occurred.

Why does "substitution bias" arise if the inflation rate is calculated based on a fixed basket of goods?

The inflation rate may be overstated because the basket of goods assumes that people will not substitute for cheaper alternatives when the prices of goods rise.

Why does the "quality/new goods bias" arise if the inflation rate is calculated based on a fixed basket of goods?

The inflation rate may be overstated if price increases are due to changes in quality rather than a decrease in the value of the currency.

What is the difference between the price level and the rate of inflation?

The rate of inflation is the change in the price level from one period to another, while the price levels itself is a gauge of overall prices throughout the economy at a particular point in time.

If inflation rises unexpectedly by 5%, would a state government that had recently borrowed money to pay for a new highway benefit or lose?

The state government would benefit because it would repay the loan in less valuable dollars than it borrowed. Plus, tax revenues for the state government would increase because of the inflation.

Table 9.4 shows the fruit prices that the typical college student purchased from 2001 to 2004. What is the amount spent each year on the "basket" of fruit with the quantities shown in column 2?

To compute the amount spent on each fruit in each year, you multiply the quantity of each fruit by the price. • 10 apples × 50 cents each = $5.00 spent on apples in 2001. • 12 bananas × 20 cents each = $2.40 spent on bananas in 2001. • 2 bunches of grapes at 65 cents each = $1.30 spent on grapes in 2001. • 1 pint of raspberries at $2 each = $2.00 spent on raspberries in 2001. Adding up the amounts gives you the total cost of the fruit basket. The total cost of the fruit basket in 2001 was $5.00 + $2.40 + $1.30 + $2.00 = $10.70. The total costs for all the years are shown in the following table. 2001 2002 2003 2004 $10.70 $13.80 $15.35 $16.31