Question

Consider the effects of inflation in an economy composed of only two people: Andrew, a bean farmer, and Beth, a rice farmer. Andrew and Beth both always consume equal amounts of rice and beans. In 2016 the price of beans was $1, and the price of rice was $4.

Suppose that in 2017 the price of beans was $2 and the price of rice was $8.

Inflation was _____%

.

Indicate whether Andrew and Beth were better off, worse off, or unaffected by the changes in prices.

	Better Off	Worse Off	Unaffected
Andrew
Beth

Now suppose that in 2017 the price of beans was $2 and the price of rice was $4.80.

In this case, inflation was _____ %

.

Indicate whether Andrew and Beth were better off, worse off, or unaffected by the changes in prices.

	Better Off	Worse Off	Unaffected
Andrew
Beth

Now suppose that in 2017, the price of beans was $2 and the price of rice was $1.60.

In this case, inflation was ____ %

.

Indicate whether Andrew and Beth were better off, worse off, or unaffected by the changes in prices.

	Better Off	Worse Off	Unaffected
Andrew
Beth

What matters more to Andrew and Beth?

The overall inflation rate

The relative price of rice and beans

Answer 1

Solution:-

Total price, i.e., the sum of prices of good B and good R, in the year 2016 was $5 (= $1+$4).

In 2017, the sum of the prices became $10(= $2 +$8).
Therefore, the inflation can be calculated using the following formula:
Inflation = Sum of prices in the year 2017 - Sum of prices in the year 2016 Inflation / Sum of price in the year 2016 * 100
= 10-5 / 5 * 100
= 5 / 5 * 100
= 100%
Therefore, the inflation was 100%
As the prices of both the goods B and R have doubled, the income also doubled and thus, the purchasing power remained the same. Therefore, both the people - D and F - are unaffected

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When the price of good B, in the year 2017, increased to $2 while that of good R increased to $4.8, then the sum of the prices became $6.8(= $2 +$4.8).
In this situation, the inflation rate became,

Inflation = Sum of prices in the year 2017 - Sum of prices in the year 2016 /  Sum of price in the year 2016 * 100
= 6.8 - 5 / 5 * 100

= 1.8 / 5 * 100

= 36%
Therefore, the inflation was 36%
Here, the price of good B has doubled, however, the price of good R has only increased slightly. Therefore, the farmer of good B, person D has become better off, while the farmer of good R, person F has become worse off.

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When the price of good B, in the year 2017, increased to $2 while that of good R decreased to $1.6, then the sum of the prices became $3.6(= $2+$1.6).
In this situation, the inflation rate became,
Inflation = Sum of prices in the year 2017 - Sum of prices in the year 2016 / Sum of price in the year 2016 * 100
= 3.6 - 5 / 5 * 100

= -1.4 / 5 * 100

= -28%

Therefore, there was deflation of 28% or the inflation was -28%.
Here, the price of good B has doubled, however, the price of good R has fallen. Therefore, the farmer of good B, person D has become better off, while the farmer of good R, person F has become worse off

In the first situation, the inflation rate was 100% but it didn't matter to any of the given two people. Therefore, what matters more to people is the relative price of good R and B.