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: 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.

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

C: 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.

D: Professors required each student to buy 10 notebooks, regardless of the price.

Answer 1

Item	Quantity	Price $	Quantity	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			1575		1890		2079
Price index			100		120		132
To get the market basket in 2015, multiply quantity and cost of each good. For example, cost of notebooks in 2015 is price of notebooks in 2015 and quantity in 2014.
To calculate the Price Index, take the price of the Market Basket of the 2015, which is the current year, and divide it by the price of the Market Basket of the base year, which is 2014, then multiply by 100.
Price index in 2015 is (1890/1575)100	120
Price index in 2016 is (2079/1575)100	132
Increase in CPSI from 2014 to 2015
(120-100)/100	20%
Increase in CPSI from 2015 to 2016
(132-120)/120	10%
The following will overstate the CPSI
Option A Substitution bias
Option B New Product bias
Option C Quality bias