Question

The table below shows this market basket and the price of each good in 2015 and 2016. For the questions below, assume that 2015 is the base year.

	2015		2016
Good	Quantity	Unit price	Unit price
Textbooks	7	$180.00	$210.00
Pizza	9	12.00	10.00
Beer	12	10.00	12.00

1. Compute the CPI in 2016 and the inflation rate between 2015 and 2016.

2. Suppose in 2016, you buy 10 textbooks instead of 7, will your answers in (a) and (b) change? Explain briefly.

Answer 1

The consumer price index tells us the increase in prices over a period of time in the basket of goods and services. It is given by the following formula:

CPI = (cost of the market basket in a given year/cost of the market basket in the base year) *100

The cost of the market basket is the sum of (price*quantity) of each good.

a.

Cost of market basket in 2015 = (7*180 + 9*12 + 12*10) = $1488

Cost of market basket in 2016 = (7*210 + 9*10 + 12*12) = $1704

Here base year is 2015 as given in the question.

Consumer price index in 2015 = (Cost of consumption basket in 2015 / cost of consumption basket in the base year) *100

Consumer price index in 2015 = (1488 / 1488) *100

= 100

Consumer price index in 2016 = (Cost of consumption basket in 2016 / cost of consumption basket in the base year) *100

Consumer price index in 2016 = (1704 / 1488) *100

= 114.51

The inflation rate measures the average increase in the price level in an economy. It is measured by the following formula:

Inflation rate = (CPI2-CPI1) / CPI1 *100

Here CPI2 is the CPI for 2016 is CPI2 and CPI for 2015 is CPI1.

Inflation rate between 2015 and 2016 = (CPI in 2016 - CPI in 2015) / CPI in 2015 *100

= (114.51-100) / 100 *100

= 14.51%

b.

If 10 textbooks is purchased instead of 7 in 2016, cost of market basket in 2016 will be:

Cost of market basket in 2016 = (10*210 + 9*10 + 12*12) = $2334

CPI in 2016 = (2334 / 1488) *100 = 156.85

Inflation between 2015 and 2016 = (156.85 - 100) / 100 *100

= 56.85%