Question

In an imaginary economy, consumers buy only shirts and pants. The fixed basket consists of 6 shirts and 4 pairs of pants.

Year	Price of a pair of pant	Price of shirt
2018	$30	$20
2019	$40	$25

Use 2018 as the base year.

1. Determine the cost of the basket for 2018 and 2019.
2. Calculate the consumer price index for 2018 and 2019.
3. Determine the inflation rate and interpret the result.
4. Explain two other use of the consumer price index.

Answer 1

A.

Cost of basket =price *quantity

2018=(30*4)+(20*6)

=120+120

=240

2019=(40*4)+(25*6)

=160+150

=310

B.

CPI =(cost of basket in current year /cost of basket in base year) *100

2018=(240/240)*100

=100.

2019=(310/240)*100

=129.17

C.

Inflation =[(cpi in year 2 - CPI in year 1) /cpi in year 1] ×100

=(129.17-100)/100]×100

=29.17%

Interpretation :

In economy overall price level is increased by 29.17%. From 2018 to 2019.

D.

1. It is used to adjust other government economic indicators.

- inflation reduces purchasing power. So, cpi helps to find the inflation and helps governments to adjust their economic indicators growth according to the inflation. It helps governments to improved standard of living and also to make other policies.

2. It is used to improve benefit level

- because CPI measures inflation, it helps people to compare their increment of wage with previous wage and find out that they actually better off. Real rate =nominal interest rate - inflation rate.