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 $1, and the price of rice was $4.

Suppose that in 2017 the price of beans was $2 and the price of rice was $8.

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 $2 and the price of rice was $4.80.

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 $2 and the price of rice was $1.60.

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?

The overall inflation rate or The relative price of rice and beans?

Answer 1

Answer:-

(A) we assume that the market basket is comprised of one unit of each good so the total market price of basket is $5 in 2016. However, as the price gets doubled in 2017, the total market price of basket also get doubled; that is, $10. Hence, the inflation rate in this case would be:

Inflation = (New price – Old price / Old price) * 100

Inflation = ($10-$5/$5) * 100

Inflation = 100%

Here, since prices of goods have doubled, so will the income of jake and latasha; therefore, both are unaffected by rise in prices.

	Better Off	Worse Off	Unaffected
Jake	no	no	yes
latasha	no	no	yes

(B)

Now, in 2017 assume that PB = $2 and PR = $4.80 then determine the inflation rate.

Here, the total market price = $6.80 ($2+$4.80) where the initial market price = $5 ($1+$4); therefore, the inflation rate can be estimated as:

Inflation = (New price – Old price / Old price) * 100

Inflation = ($6.80-$5/$5) * 100

Inflation = 36%

Here, Jake is better-off as price of beans has increased by 100% whereas the inflation was only 36%. However, Latasha is worse-off now because rise in the price of good that latasha buys overweight the rise in the price that Latasha sells.

	Better Off	Worse Off	Unaffected
Jake	yes	no	no
Latasha	no	yes	no

(C)

Now, in 2017 assume that PB = $2 and PR = $1.60 then determine the inflation rate.

Here, the total market price = $3.60 ($2+$4.80) where the initial market price = $5 ($1+$4); therefore, the inflation rate can be estimated as:

Inflation = (New price – Old price / Old price) * 100
Inflation = $3.60-$5/$5
Inflation = -28%

	Better Off	Worse Off	Unaffected
Jake	yes	no	no
Latasha	no	yes	no

(D) The relative price of rice and beans matters more to Jake and Latasha than the overall inflation rate. If the price of the good that a person produces rises more than inflation, he or she will be better off. If the price of the good a person produces rises less than inflation, he or she will be worse off.