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 2017, 2018, and 2019.

The cost of each item in the basket and the total cost of the basket are shown for 2017.

Perform these same calculations for 2018 and 2019, and enter the results in the following table.

	Quantity in Basket	2017		2018		2019
		Price	Cost	Price	Cost	Price	Cost
		(Dollars)	(Dollars)	(Dollars)	(Dollars)	(Dollars)	(Dollars)
Notebooks	15	2	30	5		8
Calculators	1	70	70	100		130
Large coffees	250	2	500	2		2
Energy drinks	50	2	100	4		6
Textbooks	10	120	1,200	150		180
Total cost			1,900
Price index			100

Suppose the base year for this price index is 2017.

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

Between 2017 and 2018, the CSPI increased by

. Between 2018 and 2019, 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.

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.

Professors required each student to buy 15 notebooks, regardless of the price.

Energy drinks became increasingly popular on college campuses between 2017 and 2019 due to significant improvements in flavor, but this quality change is hard to measure.

Answer 1

Cost = Price * quantity

2017 is base year

Price index = (cost in current year / cost in base year)*100

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CSPI is price index

Between 2017 and 2018, the CSPI increased by 25%

i.e., % change in CSPI between 2017 and 2018 = [(CSPI in 2018 - CSPI in 2017) / CSPI in 2017]*100

=> % change in CSPI between 2017 and 2018 = [(125 - 100) / 100]*100 = 25%

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Between 2018 and 2019, the CSPI increased by 20%

i.e., % change in CSPI between 2018 and 2019 = [(CSPI in 2018 - CSPI in 2019) / CSPI in 2019]*100

=> % change in CSPI between 2018 and 2019 = [(150 - 125) / 125]*100 = 20%

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Following illustrates why price indexes such as the CSPI might overstate infaltion in the cost of going to college.

• A new mobile device for personal computing became available for purchase
• 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.
• Energy drinks became increasingly popular on college campuses between 2017 and 2019 due to significant improvements in flavor, but this quality change is hard to measure.

Answer: Option (A), (B) and (D)