Question

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	2	20	1	---	3	---
Calculators	1	50	50	54	---	75	---
Large coffees	200	1	200	1	---	1	---
Energy drinks	100	2	200	3	---	4	---
Textbooks	10	100	1,000	120	---	150	---
Total cost			1,470		---		---
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.) Professors required each student to buy 10 textbooks, regardless of the price.

b.)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.

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

d.)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.

Answer 1

The table below completes the blanks where cost of the basket in any given year is arrived at by finding the sum of price and quantity of different products, fixing the quantity to base year 2014.

	Quantity in Basket	2014		2015		2016
		Price	Cost	Price	Cost	Price	Cost
		(Dollars)	(Dollars)	(Dollars)	(Dollars)	(Dollars)	(Dollars)
Notebooks	10	2	20	1	10	3	30
Calculators	1	50	50	54	54	75	75
Large coffees	200	1	200	1	200	1	200
Energy drinks	100	2	200	3	300	4	400
Textbooks	10	100	1000	120	1200	150	1500
Total cost			1,470		1,764		2,205
Price index			100		120		150

See that CSPI rises from 100 to 120 so the rate of inflation is (120 - 100)*100/100 = 20%. Similarly in 206, it rose by (150-120)*100/120 = 25%.

Between 2014 and 2015, the CSPI increased by 20 %. Between 2015 and 2016, the CSPI increased by 25%

Option B, C and D would overstate the actual inflation, Option A will not because the quantity purchased is irrespective of price.