Assignment No 1 (Week 2) Measuring the Cost of Living Question 1 If the price of building a bridge rises, is the CPI or the

GDP deflator affected more? Why? Consumer Price index: The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical household. GDP Deflator: The GDP deflator is calculated as follows

Question 2 Suppose people consume only 3 goods, as shown in this table: Tennis Balls Tennis Racquets PowerAde 2009 Price $2 $40 $1 2009 Quantity 100 10 200 2010 Price $2 $60 $2 2010 Quantity 100 10 200 a) What is the percentage change in the price of each of the three goods? What is the percentage change in the overall price level? b) Using a method similar to the CPI, compute the percentage change in the overall price level. c) If you were to learn that a bottle of PowerAde increased in size from 2009 to 2010, should that information affect your calculation of the inflation rate? If so, how? d) If you were to learn that PowerAde introduced new flavours in 2010, should that information affect your calculation of the inflation rate? If so, how? a) The price of tennis balls increases 0%; the price of tennis racquets increases ??% percent the price of Powerade increases ?? % b) To find the percentage change in the overall price level, follow these steps: Determine the fixed basket of goods: 100 balls, 10 racquets, 200 Powerades (Given in the table) Find the price of each good in each year (Given in the table) Compute the cost of the basket of goods in each year i.e., 2009 and 2010 Choose one year as a base year (2009) and compute the CPI in each year Use the CPI to compute the inflation rate from the previous year

c) Inflation rate would be over or underestimated and do we need to make an adjustment? Think about it....

d) it....

New flavours would affect the calculation of the inflation rate or NOT. Think about

Question 3 Which of the problems in the construction of the CPI might be illustrated by each of the following situations? Explain. a) b) c) d) The invention of the iPod The introduction of air-bags in cars Increased personal computer purchases in response to a decline in their price More scoops of sultanas (raisins) in each package of Sultana (Raisins) Bran (Cereals for breakfast) e) Greater use of fuel efficient cars after petrol prices increase 1 Substitution bias The basket does not change to reflect consumer reaction to changes in relative prices. Consumers substitute toward goods that have become relatively less expensive. The index overstates the increase in cost of living by not considering consumer substitution. Introduction of new goods The basket does not reflect the change in purchasing power brought on by the introduction of new products. New products result in greater variety, which in turn makes each dollar more valuable. Consumers need fewer dollars to maintain any given standard of living. Unmeasured quality changes If the quality of a good rises from one year to the next, the value of a dollar rises, even if the price of the good stays the same. If the quality of a good falls from one year to the next, the value of a dollar falls, even if the price of the good stays the same. Pakistan Bureau of Statistics tries to adjust the price for constant quality, but such differences are hard to measure.