Problem Set 4

26. Ruth collected pension benefits, which are indexed to inflation, of $220 a month in 2011. If the price index rose from 90 to 105 in the period 2011-2013, what should her pension benefits for 2013 be?

(a) $231.00 (b) $252.43 (c) $253.00 (d) $256.67 Ans: (d)

7. What is the consumer price index for 2012?

(a) 100 (b) 125 (c) 160 (d) 200 Ans: (a)

9. What was the inflation rate in 2013?

(a) 25 percent (b) 20 percent (c) 5 percent (d) 4 percent Ans: (a)

8. What is the consumer price index for 2013?

(a) 80 (b) 100 (c) 125 (d) 200 Ans: (c)

22. In 1954, Canadian Prime Minister Louis Stephen St. Laurent was paid a salary of $15 000. Stephen Harper, the Prime Minister in 2012, was paid $157 731. The price index for 1954 is 14.1 and the price index for 2012 is 121.7. What is, approximately, Prime Minister St. Laurentís salary equivalent in 2012 dollars?

(a) $110 500 (b) $114 500 (c) $129 500 (d) $211 500 Ans: (c)

11. If the consumer price index was 100 in the base year and 107 the following year, what was the inflation rate?

(a) 107 percent (b) 10.7 percent (c) 7.0 percent (d) 0.7 percent Ans: (c)

24. Andrew is offered a job in Calgary where the CPI is 120 and a job in Toronto where the CPI is 150. Andrew's job offer in Calgary is for $65 000. Which of the following salaries would the Toronto job have to pay so that both jobs have the same purchasing power?

(a) $52 000 (b) $60 266 (c) $65 625 (d) $81 250 Ans: (d)

30. In the country of Hyrkania, the CPI in 2012 was 140 and the CPI in 2013 was 154. Jake, a resident of Hyrkania, borrowed money in 2012 and repaid the loan in 2013. If the nominal interest rate on the loan was 14 percent, what was the real interest rate?

(a) 18 percent (b) 14 percent (c) 10 percent (d) 4 percent Ans: (d)

17. Research done at the Bank of Canada suggests that the sources of bias in CPI, taken together, cause the Canadian CPI to overstate increases in the cost of living. How much does the research indicate it is overstated by?

(a) 3.4 percentage points (b) 2.1 percentage points (c) 1.6 percentage points (d) 0.6 of a percentage point Ans: (d)

**6. How are the weights on the various goods and services in the CPI basket determined?

(a) Each good and service is weighted according to its quantity. (b) A survey is conducted to determine how much of each good and service typical consumers purchase. (c) The weights equal the ratio of expenditures on each good or service divided by the total consumption expenditures in the GDP accounts. (d) Each good and service is weighted according to its price. Ans: (b)

**16. What do economists believe about the bias in the CPI as a measure of the cost of living?

(a) Economists agree that the bias in the CPI is a very serious problem. (b) There is still debate among economists on whether CPI understates or overstates increases in the cost of living. (c) Economists agree on the severity of the CPI bias, but there is still debate on what to do about it. (d) There is still debate among economists on the severity of the CPI bias and what to do about it. Ans: (d)

15. When the quality of a good improves, what happens to the purchasing power of the dollar?

(a) It increases, so the CPI overstates the change in the cost of living if the quality change is not accounted for. (b) It increases, so the CPI understates the change in the cost of living if the quality change is not accounted for. (c) It decreases, so the CPI overstates the change in the cost of living if the quality change is not accounted for. (d) It decreases, so the CPI understates the change in the cost of living if the quality change is not accounted for. Ans: (a)

25. Which of the following best defines "indexation"?

(a) It is a process of adjusting the nominal interest rate so that it is equal to the real interest rate. (b) It is the use of a law or contract to automatically correct a dollar amount for the effects of inflation. (c) It is the use of a price index to deflate dollar values. (d) It is an adjustment made by Statistics Canada to the CPI so that the index is in line with the GDP deflator. Ans: (b)

13. By not taking into account the possibility of consumer substitution, how is the CPI biased?

(a) It understates the cost of living because people buy more of the newer goods. (b) It overstates the cost of living because people buy more of the cheaper goods. (c) It understates the cost of living because people have higher incomes and perceive some goods as inferior. (d) It overstates the cost of living because people have higher incomes and perceive formerly luxury goods as necessities. Ans: (b)

**20. Most, but not all, athletic apparel sold in Canada is imported from other nations. If the price of athletic apparel increases, what will happen to the GDP deflator?

(a) It will increase less than the consumer price index will. (b) It will increase more than the consumer price index will. (c) It will not increase, but the consumer price index will increase. (d) It will increase, but the consumer price index will not increase. Ans: (a)

19. Which of the following is an important difference between the GDP deflator and the consumer price index?

(a) The GDP deflator reflects the prices of goods and services bought by producers, whereas the consumer price index reflects the prices of goods and services bought by consumers. (b) The GDP deflator reflects the prices of all final goods and services produced domestically, whereas the consumer price index reflects the prices of some goods and services bought by consumers. (c) The GDP deflator reflects the prices of all final goods and services produced by a nation's citizens, whereas the consumer price index reflects the prices of final goods and services bought by consumers. (d) The GDP deflator reflects the prices of all goods and services bought by producers and consumers, whereas the consumer price index reflects the prices of final goods and services bought by consumers. Ans: (b)

**29. Suppose that the nominal interest rate was 3 percent and the inflation rate was 1 percent. What happened with the value of savings?

(a) The dollar value of savings increased at 1 percent, and the value of savings measured in goods increased at 2 percent. (b) The dollar value of savings increased at 2 percent, and the value of savings measured in goods increased at 3 percent. (c) The dollar value of savings increased at 3 percent, and the value of savings measured in goods increased at 2 percent. (d) The dollar value of savings increased at 4 percent, and the value of savings measured in goods increased at 3 percent. Ans: (c)

27. Which of the following best describes the relationship between the nominal interest rate and the real interest rate?

(a) The real interest rate is the nominal interest rate times the rate of inflation. (b) The real interest rate is the nominal interest rate minus the rate of inflation. (c) The real interest rate is the nominal interest rate plus the rate of inflation. (d) The real interest rate is the nominal interest rate divided by the rate of inflation. Ans: (b)

5. What is the basket of goods used to construct the CPI?

(a) a random sample of all goods and services produced in the economy (b) the goods and services typically bought by consumers, according to Statistics Canada surveys (c) goods and services weighted by the ratio of expenditures on them relative to the consumption component of GDP (d) the least and the most expensive goods and services in each major category of consumer expenditures Ans: (b)

14. Because the CPI is based on a fixed basket of goods, the introduction of new goods and services in the economy causes the CPI to overestimate the cost of living. Why is this?

(a) because new goods and services are always of higher quality than existing goods and services (b) because new goods and services cost less than existing goods and services (c) because new goods and services cost more than existing goods and services (d) because when a new good is introduced, it gives consumers greater choice, thus reducing the amount they must spend to maintain their standard of living Ans: (d)

23. In 1990, Professor Fellswoop made $12000, in 2000 he earned $24000, and in 2012 he earned $36000. If the CPI was 40 in 1990, 60 in 2000, and 100 in 2012, then in real terms, when was Professor Fellswoop's salary highest and lowest?

(a) highest in 1990; lowest in 2000 (b) highest in 2012; lowest in 2000 (c) highest in 2000; lowest in 1990 (d) highest in 2012; lowest in 1990 Ans: (c)

**28. What does the real interest rate tell you?

(a) how fast the number of dollars in your bank account rises over time (b) how fast the purchasing power of your bank account rises over time (c) the number of dollars in your bank account (d) the purchasing power of your bank account Ans: (b)

12. What does "substitution bias" in the consumer price index refer to?

(a) replacing old goods with new goods in consumer purchases (b) replacing low-quality goods with high-quality goods in consumer purchases (c) replacing expensive goods with cheaper goods in consumer purchases (d) replacing old-design goods with technologically advanced goods in consumer purchases Ans: (c)

3. Which of the following agencies calculates the CPI?

(a) the National Price Board (b) the Department of Weight and Measurements (c) Statistics Canada (d) the Ministry of Finance Ans: (c)

18. What does the GDP deflator reflect?

(a) the level of prices in the base year relative to the current level of prices (b) the current level of prices relative to the level of prices in the base year (c) the level of real output in the base year relative to the current level of real output (d) the current level of real output relative to the level of real output in the base year Ans: (b)

10. For any given year, what is the CPI?

(a) the price of the basket of goods and services in the given year divided by the price of the basket in the base year, then multiplied by 100 (b) the price of the basket of goods and services in the given year divided by the price of the basket in the previous year, then multiplied by 100 (c) the price of the basket of goods and services in the base year divided by the price of the basket in the given year, then multiplied by 100 (d) the price of the basket of goods and services in the previous year divided by the price of the basket in the given year, then multiplied by 100 Ans: (a)

**2. Which of the following is the consumer price index used for?

(a) to differentiate between gross national product and gross domestic product (b) to turn dollar figures into meaningful measures of purchasing power (c) to characterize the types of goods and services that consumers purchase (d) to measure the quantity of goods and services that the economy produces Ans: (b)

1. Which of the following is the consumer price index used for?

(a) to track changes in the level of wholesale prices in the economy (b) to monitor changes in the cost of living (c) to monitor changes in the level of real GDP (d) to track changes in the stock market Ans: (b)

4. How often is the CPI calculated?

(a) weekly (b) monthly (c) quarterly (d) yearly Ans: (b)

21. How often does the basket of goods in the consumer price index change?

(a) occasionally, as does the basket of goods used to compute the GDP deflator (b) yearly, as does the basket of goods used to compute the GDP deflator (c) occasionally, while the basket of goods used to compute the GDP deflator changes yearly (d) yearly, while the basket of goods used to compute the GDP deflator changes occasionally Ans: (c)