Question

ACTIVITY 2

Use the information below to calculate the CPI and inflation rate

Basket                  8 pair of shoes                  4 oil changes

Year	Price of shoes	Price of oil changes
2003	$50	$15
2004	$60	$20
2005	$70	$25
2006	$80	$30
2007	$90	$35

Compute the cost of the basket of goods.

2003

2004

2005

2006

2007

Calculate the CPI use 2003 as the base year.

2003

2004

2005

2006

2007

Calculate the inflation rate use beginning with the inflation rate between 2003 and 2004

2004

2005

2006

2007

Use the information below to calculate the CPI and the Inflation rate

Basket                  10 DVDs                             6 gallons of Milk

Year	Price of DVDs	Price of gallon of milk
2004	$8	$2
2005	$12	$3
2006	$16	$4
2007	$20	$5

Compute the cost of the basket of goods

2004

2005

2006

2007

Calculate the CPI use 2004 as the base year.

2004

2005

2006

2007

Calculate the inflation rate beginning with the inflation rate between 2004 and 2005

2005

2006

2007

Suppose a local news anchorperson in 1960 made $30,000 and the price level in 1960 was 45. Today’s price level is 210. What is the 1960’s local news anchorperson salary worth in today’s dollars.(This is similar to the Babe Ruth example in the notes

Suppose the nominal interest rate is 14% and the inflation rate is 5%. What is the real interest rate?

Suppose the real interest rate is 7% and the inflation rate is 6%. What is the nominal interest rate?

Answer 1

Cost of basket of goods in 2003 = total cost of pair of shoes + total cost of oil changes = 8*$50 + 4*$15 = $460

Cost of basket of goods in 2004 = total cost of pair of shoes + total cost of oil changes=8×$60+4×$20 = $560

Cost of basket of goods in 2005 = total cost of pair of shoes + total cost of oil changes = 8*$70+4*$25 = $660

Cost of basket of goods in 2006 = total cost of pair of shoes+ total cost of oil changes= 8*$80+4*$30 = $760

Cost of basket of goods in 2007 = total cost of pair of shoes+ total cost of oil changes=8*$90 + 4*$35 = $860

Using 2003 as the base year,

CPI for 2003=Cost of basket of goods in 2003/ cost of basket of goods in base year * 100 = 460/460*100 =100

CPI for 2004 = cost of baskets of goods in 2004 / cost of basket of goods in base year *100 = 560/460*100 = 121.74

CPI for 2005= cost of basket of goods in 2005/ cost of basket of goods in base year*100= 660/460*100 = 143.48

CPI for 2006 = cost of basket of goods in 2006 / cost of basket of goods in base year*100 =760/460*100=165.2

CPI for 2007 = cost of basket of goods in 2007/ cost of basket of goods in base year*100=860/460*100= 187

Inflation rate for 2004 =( CPI for 2004 - CPI for 2003)/CPI for 2003 *100 = (121.74-100)/100*100 =21.74%

Inflation rate for 2005=( CPI for 2005-CPI for 2004)/CPI for 2004*100 = (143.48-121.74)/121.74*100 = 17.86%

Inflation rate for 2006 = (CPI for 2006 - CPI for 2005)/ CPI for 2005*100 = (165.2-143.48)/143.48*100 = 15.14%

Inflation rate for 2007 = (CPI for 2007 - CPI for 2006)/CPI for 2006*100 = (187-165.2)/165.2*100 = 13.2%