Question 1

An ideal cost-of-living index measures:

Accepted Answer

An ideal cost-of-living index should measure the relative cost of maintaining a particular utility level, which takes into account the prices of goods and services that are essential for maintaining a certain standard of living. This is because consumers are interested in maintaining a certain level of satisfaction or utility when making purchasing decisions, and a cost-of-living index that reflects these preferences would be the most relevant and useful for consumers and policy-makers.

Question 2

The purpose of a chain-weighted price index is to account for:

Accepted Answer

A chain-weighted price index is designed to account for changes in the quantities of goods and services purchased over time. It does this by giving greater weight to more recent prices and adjusting for changes in consumer behavior by using current prices as a reference point. This makes it a more accurate measure of inflation than traditional price indexes which may not take into account changes in consumer behavior and may overstate inflation. The index does not relate to the costs of purchasing wholesale products like chains and industrial goods, nor does it account for linkages in price changes among industrialized countries.

Question 3

Suppose that a consumer's increase in nominal income from the base year is exceeded by the inflation level given by a Paasche cost of living index for their level of purchases:  Show that this information implies that the consumer is strictly worse-off as compared to the base year. (Hint: Use a revealed preference argument.)

Accepted Answer

The answer of Suppose that a consumer's increase in nominal...

Question 4

Suppose the table below lists the price and consumption levels of food and clothing during 1990 and 2000. Calculate a Laspeyres and Paasche index using 1990 as the base year.

Accepted Answer

The answer of Suppose the table below lists the price...

Question 5

You using a Laspeyres (fixed-weight) price index to compare price changes over time, and the index is based on consumption bundles from 2005 when energy costs were lower and housing costs were higher. Your results are likely to:

Accepted Answer

Since the Laspeyres price index is based on consumption bundles from 2005, it assigns a higher weight to housing costs and a lower weight to energy costs. Over time, energy costs have increased significantly while housing costs have not increased at the same rate. Therefore, the fixed-weight index would overstate changes in the cost of living because the weight assigned to energy is too large.

Question 6

Before the adoption of a chain-weighted price index in the United States, the payments based on changes in the Consumer Price Index (CPI) tended to be:

Accepted Answer

The system used a Laspeyres index, which tends to overstate inflation because it does not account for changes in consumer behavior in response to price changes, leading to payments that are too large.

Question 7

The key reason that the Laspeyres price index tends to overstate the impact of price changes on consumers is that it:

Accepted Answer

The Laspeyres price index only considers a fixed basket of goods and ignores the possibility that consumers may change their consumption patterns in response to price changes. This means that it may overstate the true impact of price changes on consumers. Option A is incorrect because the Laspeyres index does consider both price increases and decreases. Option B is incorrect because the Laspeyres index typically uses current period prices to calculate the index, not prices from two periods after the actual price changes occurred.

Question 8

May enjoys spending her free time with her friends at the mall and solving problems from her microeconomics text. She has 16 hours per week of free time. Diagram May's time constraint. If  and  where F is her time spent with friends at the mall and P is her time spent working problems, how much time should May spend at each activity?

Accepted Answer

The answer of May enjoys spending her free time with...

Question 9

The Laspeyres price index tends to ________ the ideal cost-of-living index.

Accepted Answer

The Laspeyres price index tends to overestimate the cost of living because it uses a fixed basket of goods and does not account for substitutions that consumers may make in response to changes in prices. As a result, it often includes goods with a higher price than what consumers actually buy, leading to a higher index value than the ideal cost-of-living index.

Question 10

Suppose that a consumer's increase in nominal income from the base year exceeds the inflation level given by a Paasche cost of living index for their level of purchases:  Is this information enough to imply how the consumer's level of well-being has changed? (Hint: Use a revealed preference argument.)

Accepted Answer

The answer of Suppose that a consumer's increase in nominal...

Question 11

Which price index tends to understate the impact of price changes on consumers?

Accepted Answer

The Paasche index tends to understate the impact of price changes on consumers because it uses current period quantities, which can reflect substitution effects that consumers make in response to price changes, thus potentially underestimating the cost of maintaining the same standard of living.

Question 12

The ideal cost-of-living index represents:

Accepted Answer

The ideal cost-of-living index should measure the cost of attaining a given level of utility at current prices relative to the cost of attaining the same utility at base-year prices. This allows for the comparison of prices over time and adjusts for inflation. Option A is not ideal as it does not take into account changes in prices over time. Option B is also not ideal as it assumes constant prices, which is unrealistic. Option D is not realistic as cost-of-living indexes cannot guarantee that everyone will be better off.

Question 13

Suppose that a consumer's increase in nominal income from the base year exceeds the inflation level given by a Laspeyres cost of living index for their level of purchases :  Show that this information implies that the consumer is strictly better-off as compared to the base year. (Hint: Use a revealed preference argument.)

Accepted Answer

The answer of Suppose that a consumer's increase in nominal...

Question 14

Which of the following statements about the composition of price indices is NOT true?

Accepted Answer

The Paasche index uses current-year quantities for the bundle, not base-year quantities. This is what differentiates it from the Laspeyres index, which uses base-year quantities.

Quiz 3: Consumer Behavior

An ideal cost-of-living index measures:

The purpose of a chain-weighted price index is to account for:

Suppose the table below lists the price and consumption levels of food and clothing during 1990 and 2000. Calculate a Laspeyres and Paasche index using 1990 as the base year.

You using a Laspeyres (fixed-weight) price index to compare price changes over time, and the index is based on consumption bundles from 2005 when energy costs were lower and housing costs were higher. Your results are likely to:

Before the adoption of a chain-weighted price index in the United States, the payments based on changes in the Consumer Price Index (CPI) tended to be:

The key reason that the Laspeyres price index tends to overstate the impact of price changes on consumers is that it:

The Laspeyres price index tends to ________ the ideal cost-of-living index.

Which price index tends to understate the impact of price changes on consumers?

The ideal cost-of-living index represents:

Which of the following statements about the composition of price indices is NOT true?