Question

1. Given that the price index in the previous (month) was 1.05 and the expected price in the previous period was 1.00.

a.) What would be the current expected price "Range" if adaptive expectations were used?

Answer 1

In this method the past information of inflation should be considered for current period calculation.

The rate of inflation in the last month = (1.05 – 1) × 100

                                                            = 0.05 × 100

                                                            = 5%

Since the last month’s price index was 1.05, it should be the normal price in the current month as well.

The normal price would be increased by inflation.

Current year’s expected price index = Normal price × (1 + inflation rate)

                                                            = 1.05 × (1 + 0.05)

                                                            = 1.05 × 1.05

                                                            = 1.1025

Required price range: 1.05 to 1.1025