Question

5. Problems and Applications Q5

Consider the effects of inflation in an economy composed of only two people: Lorenzo, a bean farmer, and Neha, a rice farmer. Lorenzo and Neha both always consume equal amounts of rice and beans. In 2019 the price of beans was $1, and the price of rice was $3.

Suppose that in 2020 the price of beans was $2 and the price of rice was $6.

Inflation was_______?

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

	Better Off	Worse Off	Unaffected
Lorenzo
Neha

Now suppose that in 2020 the price of beans was $2 and the price of rice was $4.50.

In this case, inflation was______?

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

	Better Off	Worse Off	Unaffected
Lorenzo
Neha

Now suppose that in 2020, the price of beans was $2 and the price of rice was $1.50.

In this case, inflation was______?

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

	Better Off	Worse Off	Unaffected
Lorenzo
Neha

What matters more to Lorenzo and Neha?

a. The overall inflation rate

b. The relative price of rice and beans

Answer 1

Inflation rate=

{CPI( 2020)- CPI(2019) ÷ CPI( 2019)} ×100

Consumer price Index( CPI)= summation R/N

where R= (P1/P0) ×1000

P1= prices of 2020

P0= prices of 2019

N= number of crops=2

Farmers	Crops	Price(2019) P0 $	Case 1	Case....2 P2(2020) $	Case 2 R2 (P2/P0)100	Case......3 P3(2020) $	R3=(P3/P0)100
Price (2020) P1 $	R1
(P1/P0)100
Lorenzo	beans	1	2	(2/1)100=200	2	2/1×100=200	2	2/1×100=200
Neha	Rice	3	6	(6/3)100=200	4•50	4•5/3×150	1•50	1•50/3×100=50
				Sum of R1= 400		Sum of R=350		Sum of R= 250

CASE---1( when beans price =$2 & rice price =$6)

CPI= 400/2= 200

Inflation rate= (200-100÷100)×100=100%

* Inflation rate= 100%

* Both farmers are unaffected by change in price.

Reason-- Inflation rate and percentage prices both are

CASE. -- 2( when beansprice=$2& rice price =$ 4•50)

CPI= 350/2=175

Inflation rate= (175-100/100)100=75%

* Inflation rate= 75%

* Lorenzo is better off while Neha is worse off

Reason--

Price of beans rises by 100% while inflation rate is 75% ,so lorenzo is better off.On the other hand, price of rice increase by 50% while inflation rate is 75%, Neha is worse off.

Case ---3 ( price of beans=$2, price of rice=$1•50)

CPI= 250/2=125

Inflation rate= (125-100/100)100= 25%

* Inflation rate= 25%

* Lorenzo is better off while Neha is worse off

Reason-- price of beans rise by 100© whe inflation rate is less than is(25%), so Lorenzo is better off while the price of rice fall by 50% and inflation rate is 25%, so neha is worse off.

*