Question

4. Suppose that people consume only three goods. Also assume that quantities of the goods are fixed during this period of time, as follows: 100 tennis balls, 10 tennis racquets, and 200 Gatorade bottles. The prices of the goods for the years 2011 and 2012 are shown in the table below

Year	Balls	Racquets	Gatorade
2011	$2	$40	$1
2012	$2	$60	$2

1. What is the percentage change in the price of each of the three goods? What is the percentage change in the overall price level?

2. Do tennis racquets become more or less expensive relative to Gatorade? Does the well- being of some people change relative to the well-being of others? Explain.

Answer 1

Percentage change in the price of Balls = [($2 - $2) / $2] * 100 = 0%

Percentage change in the price of Racquets = [($60 - $40) / $40] * 100 = 50%

Percentage change in the price of Gatorade = [($2 - $1) / $1] * 100 = 100%

To calculate the percentage change in the overall price level we have to calculate CPI:

The cost of the basket of goods 2011 = (100 * $2) + (10 *$40) + (200 *$1) = $800

The cost of the basket of goods 2012 = (100 * $2) + (10 *$60) + (200 *$2) = $1200

Here, 2011 is base year.

CPI in 2011 = ($800 / $800) * 100 = 100

CPI in 2011 = ($1200 / $800) * 100 = 150

The percentage change in the overall price level = [(150 - 100) / 100] * 100 = 50%

Tennis racquets are less expensive relative to Gatorade, because the price of racquets rose by 50% while the price of Gatorade rose by 100%. The well-being of some people changes relative to the well-being of others. The people who purchase more of Gatorade become worse off relative to those people who purchase more of tennis racquets or tennis balls.