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 type of personal transporter, which made it easier to get around places like university campuses, became available for purchase.

The quality of textbooks increased dramatically from 2017 to 2019, with textbook companies bundling new online study aids with their books, but this quality change is hard to measure.

As the price of energy drinks increased relative to the price of coffee between 2017 and 2019, students decreased their consumption of energy drinks and increased their consumption of coffee.

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

Answer 1

Cost = Quantity*Price

Price index = total cost in the year/total cost in the base year 2017*100

Inflation = Price index in the current year-Price index last year/Price index last year*100

	Quantity in Basket	2017	2018	2019
Price	Cost	Price	Cost	Price	Cost
(Dollars)	(Dollars)	(Dollars)	(Dollars)	(Dollars)	(Dollars)
Notebooks	15	2	30	5	75	8	120
Calculators	1	70	70	100	100	130	130
Large coffees	250	2	500	2	500	2	500
Energy drinks	50	2	100	4	200	6	300
Textbooks	10	120	1,200	150	1500	180	1800
Total cost			1,900		2375		2850
Price index			100		125		150

Base year for this price index is 2017.

Between 2017 and 2018, the CSPI increased by 125-100/100*100 = 25%

Between 2018 and 2019, the CSPI increased by 150-125/125*100 = 20%

All options except the following are correct -

-Professors required each student to buy 15 textbooks, regardless of the price

Because inflation will overstate when the quality of the goods has improved due to technology or when people buy substitute goods