Question

1. Calculating inflation using a simple price index

Consider a fictional price index, the College Student Price Index (CSPI), based on a typical college student’s annual purchases. Suppose the following table shows information on the market basket for the CSPI and the prices of each of the goods in 2014, 2015, and 2016.

The cost of each item in the basket and the total cost of the basket are shown for 2014.

Perform these same calculations for 2015 and 2016, and enter the results in the following table.

	Quantity in Basket	2014		2015		2016
		Price	Cost	Price	Cost	Price	Cost
		(Dollars)	(Dollars)	(Dollars)	(Dollars)	(Dollars)	(Dollars)
Notebooks	10	3	30	3		4
Calculators	1	75	75	80		104
Large coffees	300	2	600	2		2
Energy drinks	75	2	150	4		5
Textbooks	8	90	720	110		120
Total cost			1,575
Price index			100

Suppose the base year for this price index is 2014.

In the last row of the table, calculate and enter the value of the CSPI for the remaining years.

Between 2014 and 2015, the CSPI increased by

. Between 2015 and 2016, the CSPI increased by _____?

.

Which of the following, if true, would illustrate why price indexes such as the CSPI might overstate inflation in the cost of going to college? Check all that apply.

A new mobile device for personal computing became available for purchase.

Professors required each student to buy eight textbooks, regardless of the price.

Energy drinks became increasingly popular on college campuses between 2014 and 2016 due to significant improvements in flavor, but this quality change is hard to measure.

As the price of calculators rose, fewer students decided to buy them, opting instead to use the free calculators in their cell phones or on their computers.

4. Inflation and interest rates

The following table shows the average nominal interest rates on six-month Treasury bills between 1963 and 1967, which determined the nominal interest rate that the U.S. government paid when it issued debt in those years. The table also shows the inflation rate for the years 1963 to 1967. (All rates are rounded to the nearest tenth of a percent.)

Year	Nominal Interest Rate	Inflation Rate
	(Percent)	(Percent)
1963	3.3	1.3
1964	3.7	1.3
1965	4.1	1.6
1966	5.1	2.9
1967	4.6	3.1

Source: “Economic Report of the President (2007),” United States Government Printing Office, last modified February 1, 2007, accessed March 11, 2013, http://www.gpo.gov/fdsys/pkg/ERP-2007/pdf/ERP-2007.pdf.

On the following graph, use the orange points (square symbol) to plot the nominal interest rates for the years 1963 to 1967. Next, use the green points (triangle symbol) to plot the real interest rates for those years.

According to the table, in which year did buyers of six-month Treasury bills receive the highest real return on their investment?

1963

1964

1965

1966

1967

Answer 1

1.)

	QUANTITY IN BASKET	2014		2015		2016
		PRICE ($)	COST ($)	PRICE ($)	COST ($)	PRICE ($)	COST ($)
Notebooks	10	3	30	3	30	4	40
Calculators	1	75	75	80	80	104	104
Large Coffees	300	2	600	2	600	2	600
Energy Drinks	75	2	150	4	300	5	375
Textbooks	8	90	720	110	880	120	960
Total Cost			1,575		1,890		2,097
Price Index			100		115.69		136.62

Keeping the base year as 2014, Price index is calculated as

CSPI = (Sum of current prices / Sum of base prices) * 100

CSPI (2015) = 199/172 * 100

= 115.69

CSPI (2016) = 235/172 * 100

=136.62

• Between 2014 and 2015, the CSPI increased by 15.69%

• Between 2015 and 2016, the CSPI increased by 18.1%

• The CSPI might overstate inflation in the cost of going to college because, Professors required each student to buy eight textbooks, regardless of the price.

.