Question

Consider the effects of inflation in an economy composed of only two people: Jake, a bean farmer, and Latasha, a rice farmer. Jake and Latasha both always consume equal amounts of rice and beans. In 2016 the price of beans was $5, and the price of rice was $3.

Suppose that in 2017 the price of beans was $10 and the price of rice was $6.

Inflation was ____________%.

Indicate whether Jake and Latasha were better off, worse off, or unaffected by the changes in prices.

	Better Off	Worse Off	Unaffected
Jake
Latasha

Now suppose that in 2017 the price of beans was $7.50 and the price of rice was $6.

In this case, inflation was ___________%.

Indicate whether Jake and Latasha were better off, worse off, or unaffected by the changes in prices.

	Better Off	Worse Off	Unaffected
Jake
Latasha

Now suppose that in 2017, the price of beans was $1.50 and the price of rice was $6.

In this case, inflation was_______%.

Indicate whether Jake and Latasha were better off, worse off, or unaffected by the changes in prices.

	Better Off	Worse Off	Unaffected
Jake
Latasha

What matters more to Jake and Latasha?

a. The relative price of rice and beans

b. The overall inflation rate

Answer 1

Solution:-

(a) 2016 the price of bean and rice was $ 5 +$ 3 = $8

In 2017 the price of bean as well as rice is $10 +$6 = 16

Inflation = Cost of basket 2017 - Cost of basket 2016 / Cost of basket 2016 * 100

              = $16 - $8 / $8 * 100

              = 100%

Both Jake and Latasha will be unaffected by the change in price.

(b) In 2017 the price of the bean as well as rice is $7.50 +$6 = 13.5

Similarly, the cost of the market basket in 2016 is $ 8.

Inflation = Cost of basket 2017 - Cost of basket 2016 / Cost of basket 2016 * 100

              = $13.5 - $8 / $8 * 100

              = 5.5 / 8 * 100

              = 68.75%

Gilberto - Worse off

Juanita - Better off

(c) In 2017 the price of bean as well as rice is $1.50 +$6 = 7.50

Similarly, the cost of market basket in 2016 is $ 8.

Inflation = Cost of basket 2017 - Cost of basket 2016 / Cost of basket 2016 * 100

              = $7.50 - $8 / $8 * 100

              = -0.50 / 8 * 100

              = -6.25%

Gilberto - Worse off

Juanita - Better off

4. Both consume an equal amount of rice and bean. Hence for both the relative price of rice and beans matter.