Question 1

The price level is:

Accepted Answer

The price level is a measure of overall prices at a particular point in time.

Question 2

The price of a specific good in comparison to the prices of other goods and services is called:

Accepted Answer

A relative price is the price of a specific good in comparison to the prices of other goods and services.

Question 3

________ is an increase in the price level, while ________ is an increase in the price of one good in comparison to other goods and services.

Accepted Answer

This is the definition of both "inflation" and the definition of "relative price increase."

Question 4

A change in the average price level is called ________, while a change in the price of a specific good in comparison with other goods and services is called ________.

Accepted Answer

These are the definitions of "inflation" and "changes in relative prices."

Question 5

The quality adjustment bias of the CPI refers to the failure of statisticians to:

Accepted Answer

The quality adjustment bias of the CPI refers to the failure of statisticians to take into account improvements in goods and services.

Question 6

Product improvements make it difficult for the statisticians who construct the CPI to distinguish between ________ changes and ________ changes.

Accepted Answer

The price index seeks to compare prices of goods and services while keeping the quality of goods and services constant. But products are always changing and usually changing for the better. It is common for both prices and quality to go up at the same time.

Question 7

Suppose that the price of chicken rises sharply compared to the price of turkey. In response, consumers buy more turkey and less chicken than they did in the CPI base year. In this situation the CPI will tend to ________ inflation as a result of ________ bias.

Accepted Answer

When prices rise sharply for a product, consumers shift away from it. Since the CPI uses a fixed basket of goods and services, this switching between substitute products is often missed, resulting in "substitution bias" and overstatement of the CPI.

Question 8

The substitution bias in the CPI refers to the failure of statisticians to:

Accepted Answer

When prices rise sharply for a product, consumers shift away from it. Since the CPI uses a fixed basket of goods and services, this switching between substitute products is often missed, resulting in "substitution bias."

Question 9

When statisticians fail to allow for the possibility that consumers switch from products with rising prices to those whose prices are stable or falling, the CPI will tend to ________ the rate of inflation.

Accepted Answer

When prices rise sharply for a product, consumers shift away from it. Since the CPI uses a fixed basket of goods and services, this switching between substitute products is often missed, resulting in "substitution bias" and overstatement of the CPI.

Question 10

To counteract relative price changes, the government would implement:

Accepted Answer

If the government doesn't like relative price changes that make a specific good, like milk, more expensive then the government must use policies that affect the supply and demand for that particular good or service.

Question 11

If the price of motel rooms increases by 10 percent while the prices of other goods and services increase by 5 percent on average, the relative price of motel rooms has:

Accepted Answer

In this case, motel rooms prices increased by more than other goods and services so the relative price of motel rooms increased.

Question 12

Two types of bias that tend to cause the CPI to overstate the "true" rate of inflation are the ________ bias and the ________ bias.

Accepted Answer

Two types of bias that tend to cause the CPI to overstate the 'true' rate of inflation are substitution bias and quality adjustment bias.

Question 13

Suppose the value of the CPI is 1.100 in year one, 1.210 in year two, and 1.331 in year three. Assume also that the price of computers increases by 3 percent between year one and year two, and by another 3 percent between year two and year three. The price level is increasing, the inflation rate is ________, and the relative price of computers is ________.

Accepted Answer

The inflation rate is constant because the rate of change is the same in both years: (1.210 - 1.100)/ 1.100 = = 0.1 or 10 percent and (1.331 - 1.210)/ 1.210 = 0.1 or 10 percent. The relative price of computers is decreasing because its 3 percent rate of price change is less than the inflation rate in both years.

Question 14

Suppose the value of the CPI is 1.100 in year one, 1.160 in year two, and 1.270 in year three. Assume also that the price of computers increases by 3 percent between year one and year two, and by another 3 percent between year two and year three. The price level is increasing, the inflation rate is ________, and the relative price of computers is ________.

Accepted Answer

The inflation rate is increasing because the rate of change is increasing from year one to year two: (1.160 - 1.100)/ 1.1 = 0.0545 or 5.45 percent and (1.270 - 1.160)/ 1.160 = 0.0948 or 9.48 percent. The relative price of computers is decreasing because its 3 percent price change is less than the inflation rate in both years.

Question 15

Suppose the value of the CPI is 1.100 in year one, 1.122 in year two, and 1.133 in year three. Assume also that the price of computers increases by 3 percent between year one and year two, and by another 3 percent between year two and year three. The price level is increasing, the inflation rate is ________, and the relative price of computers is ________.

Accepted Answer

The inflation rate is decreasing because the rate of change is falling from year one to year two: (1.122 - 1.100)/ 1.122 = 0.02 or 2 percent versus (1.133 - 1.122)/ 1.122 = 0.01 or 1 percent. The relative price of computers is increasing because its price change of 3 percent exceeds inflation rate in both years.

Question 16

The substitution bias in the CPI arises because the CPI:

Accepted Answer

The CPI uses a historical market basket of goods so the index will not reflect any substitution that has occurred and, thus, overstates inflation.

Question 17

A relative price is:

Accepted Answer

A relative price is the price of a specific good in comparison to the prices of other goods and services.

Question 18

A measure of overall prices at a particular point in time is called:

Accepted Answer

The price level is a measure of overall prices at a particular point in time.

Question 19

When consumers substitute a cheaper good for a more expensive one, the CPI will ________ the change in the cost of living.

Accepted Answer

The CPI uses a historical market basket of goods so the index will not reflect any substitution that has occurred and, thus, overstates inflation.

Question 20

If all prices, including the price of beef, increase by 3 percent, then the relative price of beef has ________ and inflation ________.

Accepted Answer

In this case, the price of beef rose at the same rate as the general price level. Thus the relative price of beef was constant although inflation occurred at a rate of 3 percent.

Quiz 18: Measuring the Price Level and Inflation

The price level is:

The price of a specific good in comparison to the prices of other goods and services is called:

is an increase in the price level, while is an increase in the price of one good in comparison to other goods and services.

A change in the average price level is called , while a change in the price of a specific good in comparison with other goods and services is called .

The quality adjustment bias of the CPI refers to the failure of statisticians to:

Product improvements make it difficult for the statisticians who construct the CPI to distinguish between changes and changes.

Suppose that the price of chicken rises sharply compared to the price of turkey. In response, consumers buy more turkey and less chicken than they did in the CPI base year. In this situation the CPI will tend to inflation as a result of bias.