Question 1

Suppose OPEC succeeds in raising world oil prices by 300 percent.This price increase causes inventors to look at alternative sources of fuel for internal-combustion engines.A hydrogen-powered engine is developed,and it is cheaper to operate than gasoline engines.Which of the following problems in the construction of the CPI would this situation represent,respectively?

Accepted Answer

The situation represents substitution bias as consumers may switch to cheaper alternatives like hydrogen engines, and introduction of new goods as the hydrogen engine is a new product in the market.

Question 2

When the quality of a good deteriorates,what happens to the purchasing power of the dollar?

Accepted Answer

When the quality of a good deteriorates, the purchasing power of the dollar decreases, meaning it can buy fewer goods of the same quality. As a result, the CPI (Consumer Price Index) would understate the change in the cost of living if the quality change is not accounted for. This is because the CPI measures changes in the overall price level, but if the quality of goods is deteriorating, then the CPI may not accurately reflect the true change in the cost of living.

Question 3

What does the GDP deflator reflect?

Accepted Answer

The GDP deflator reflects the current level of prices relative to the level of prices in the base year.

Question 4

By not taking into account the possibility of consumer substitution,how is the CPI biased?

Accepted Answer

The Consumer Price Index (CPI) is biased towards overstating the cost of living because it does not fully account for consumer substitution between goods. When prices of certain goods increase, consumers may switch to cheaper alternatives, but the CPI calculation might not fully capture this behavior, leading to an overstatement of how much consumers are actually spending.

Question 5

What do economists believe about the bias in the CPI as a measure of the cost of living?

Accepted Answer

While there is agreement among economists that the CPI has a bias as a measure of the cost of living, there is still debate on the severity of the bias and what actions should be taken to address it. Some economists argue that the CPI overstates the cost of living increases, while others believe it understates them. This ongoing debate among economists is reflected in the different proposals put forth for adjusting the CPI to account for the bias. Therefore, option D is the best answer.

Question 6

For some racquet sports,there have been increases in the size of the racquets and the methods and materials used for making them have improved.Which of the following problems in the construction of the CPI is this change in racquets most relevant to?

Accepted Answer

The change in racquets is most relevant to the problem of unmeasured quality change, as it represents an improvement in the quality of the product that is not reflected in the CPI. This can lead to an overestimation of inflation and a distortion of price trends.

Question 7

Which of the following problems in the construction of the CPI is the invention of pocket-sized computers most relevant to?

Accepted Answer

The invention of pocket-sized computers is relevant to the problem of introduction of new goods in the calculation of the CPI. The introduction of new goods can affect the measurement of the cost of living if they are not properly accounted for in the index. Pocket-sized computers are a fairly recent innovation and are likely to have been introduced after the base period used for the CPI was established. Therefore, their inclusion in the basket of goods used to calculate the CPI could have a significant impact on the index.

Question 8

Research done at the Bank of Canada suggests that the sources of bias in CPI,taken together,cause the Canadian CPI to overstate increases in the cost of living.How much does the research indicate it is overstated by?

Accepted Answer

The research from the Bank of Canada indicates that the Canadian CPI overstates increases in the cost of living by 0.6 of a percentage point.

Question 9

When the relative price of a good increases,how will consumers respond?

Accepted Answer

When the relative price of a good increases, it becomes more expensive compared to its substitutes. Therefore, consumers tend to buy less of that good and more of its substitutes, resulting in a shift in demand towards the substitutes. This is known as the substitution effect.

Question 10

Which of the following problems in the construction of the CPI is the creation of the mobile phone most relevant to?

Accepted Answer

The introduction of new goods refers to the challenge of incorporating new products and services into the CPI, particularly if they weren't previously available or only available to certain groups. The creation of the mobile phone is an example of the introduction of a new good, and its widespread adoption has had a significant impact on the way people communicate and consume media, making it relevant to the CPI.

Question 11

Suppose the quality of lawn mowers,which are part of the CPI basket,has improved,while their price has remained the same.If Statistics Canada wants to adjust the CPI so that the effect of better quality on the cost of living is accounted for,what should Statistics Canada do?

Accepted Answer

The answer of Suppose the quality of lawn mowers,which are...

Question 12

Consumers begin purchasing houses incorporating steel studs instead of wooden studs after the price of lumber increases.Which of the following problems in the construction of the CPI does this situation best represent?

Accepted Answer

This situation represents substitution bias because the CPI assumes a fixed basket of goods, including housing with wooden studs. However, consumers are substituting steel studs for wooden studs which are not reflected in the CPI.

Question 13

Why are measurement problems in the consumer price index as an indicator of the cost of living important?

Accepted Answer

Many government programs use the CPI to adjust for changes in the overall level of prices, such as Social Security payments and the calculation of poverty thresholds. Therefore, measurement problems in the CPI can have significant implications for the distribution of income and government spending.

Question 14

When the quality of a good improves,what happens to the purchasing power of the dollar?

Accepted Answer

When the quality of a good improves, the value you get for each dollar spent on the good increases, effectively increasing the purchasing power of the dollar. However, if the Consumer Price Index (CPI) does not adjust for this quality improvement, it may suggest that consumers are getting less for their money than they actually are, thus overstating the change in the cost of living.

Question 15

Suppose the price of a litre of milk rises from $1 to $1.25 and the price of a T-shirt rises from $8 to $10.If the CPI rises from 150 to 175,what will people likely buy?

Accepted Answer

A rise in CPI indicates a general increase in the prices of goods and services in the market. This means people's purchasing power has decreased. As a result, people are likely to buy fewer goods and services than before. In this case, the increase in prices of both milk and T-shirts will lead people to buy less of both, so the correct choice is D - less milk and fewer T-shirts.

Question 16

Because the CPI is based on a fixed basket of goods,the introduction of new goods and services in the economy causes the CPI to overestimate the cost of living.Why is this?

Accepted Answer

The answer of Because the CPI is based on a...

Question 17

Samantha goes to the grocery store to make her monthly purchase of ginger ale.As she enters the soft drink section,she notices that the price of ginger ale has been raised by 15 percent,so she decides to buy some peppermint tea instead.Which of the following problems in the construction of the CPI is this situation most relevant to?

Accepted Answer

This situation is most relevant to substitution bias in the construction of the CPI. Samantha chose to buy peppermint tea instead of ginger ale due to the increase in price. This decision reflects the fact that consumers will substitute goods if their prices change, which is not always fully accounted for in the CPI.

Question 18

Suppose the price of a carton of ice cream rises from $4 to $5 and the price of coffee rises from $2 to $2.50.If the CPI rises from 150 to 200,what will people likely buy?

Accepted Answer

The answer of Suppose the price of a carton of...

Question 19

Suppose that dairy products have risen in price less than prices in general over the past several years.Which of the following problems in the construction of the CPI is this price increase most relevant to?

Accepted Answer

This price increase is most relevant to substitution bias, which occurs when consumers switch to lower-priced goods when the price of a good increases. If the price increase of dairy products is less than the average price increase, then consumers may be more likely to substitute dairy products for more expensive goods, leading to an overestimation of the level of inflation in the CPI.

Question 20

Laura bought word processing software for $50.A year later,Laura's twin brother Laurence bought an upgraded version of the same software for $50.Which of the following problems in the construction of the CPI does this situation best represent?

Accepted Answer

This situation represents unmeasured quality change because the software was upgraded, implying an improvement in quality, but the price remained the same. This change in quality is not reflected in the CPI calculation.

Quiz 6: Measuring the Cost of Living