Question 1

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 2

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 3

A labor contract provides for a first-year wage of $15 per hour, and specifies that the real wage will rise by 2 percent in the second year of the contract. The CPI is 1.00 in the first year and 1.09 in the second year. What dollar wage must be paid in the second year?

Accepted Answer

To find the indexed wage in year two, the wage that would maintain the purchasing power from the first year, take the nominal wage in year one and multiply it by the CPI:, $15 × 1.09 = $16.35. Then, since the contract calls for an increase in the real wage by 3%, the indexed wage must be increased by 2 percent: $16.35 × 1.02 = $16.68.

Question 4

If the price of motel rooms increases by 10% while the prices of other goods and services increase by 5% 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 5

If all prices, including the price of beef, increase by 3%, 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%.

Question 6

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

Question 7

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 8

Two methods used to adjust nominal values for inflation are:

Accepted Answer

Indexing increases nominal amounts by the rate of inflation each year to maintain a certain real value, while deflating is the process of obtaining real values from nominal ones.

Question 9

When statisticians fail to take into account improvements in the quality of goods and services, the CPI will tend to ______ the rate of inflation.

Accepted Answer

It's hard to correctly factor in improvement to the quality of goods and services. To the extent that quality improvements are not fully accounted for, the CPI overstates the "true" inflation rate.

Question 10

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% between year one and year two, and by another 3% 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 ears two: (1.122 -1.100) / 1.122 = 0.02 or 2% versus (1.133 - 1.122) / 1.122 = 0.01 or 1%. The relative price of computers is increasing because its price change of 3% exceeds inflation rate in both years.

Question 11

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 12

The price level is:

Accepted Answer

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

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% between year one and year two, and by another 3% 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% and (1.331 - 1.210) / 1.210 = 0.1 or 10%. The relative price of computers is decreasing because its 3% rate of price change is less than the inflation rate in both years.

Question 14

If CPI overstates the "true" inflation rate, then indexing Social Security benefits to the CPI:

Accepted Answer

If the CPI overstates the "true" inflation rate, anything indexed to the CPI will over-correct for inflation. This overstating costs the federal government billions of dollars each year.

Question 15

Suppose the CPI does indeed overstate the inflation rate. When the CPI increases by 5% and household incomes increase by 5%, we should conclude that real incomes of households have:

Accepted Answer

The overstatement of the CPI is about 2 percent. So the "true" inflation rate would be the inflation rate based on the CPI minus two percent: 5% - 2% = 3%. So if household income increased by 5%, then incomes have increased more than the 3% "true" rate of inflation, and real income has increased.

Question 16

Suppose manufacturers introduce a new model car to replace a car currently included in the CPI basket. The price of the new car is 10 percent higher than the discontinued model, but the new car has additional safety features and amenities. In this situation the CPI will tend to ______ inflation as a result of ______ bias.

Accepted Answer

The CPI did not fully reflect the higher quality of the new car, so it overstated the price increase. This is called "quality adjustment" bias.

Question 17

To ensure that a nominal payment represents a constant level of purchasing power over time, one should:

Accepted Answer

To keep nominal amounts constant in real terms, increase nominal amounts by the rate of inflation each year.

Question 18

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 19

A labor contract provides for a first-year wage of $10 per hour, and specifies that the real wage will rise by 3 percent in the second year of the contract. The CPI is 1.00 in the first year and 1.07 in the second year. What dollar wage must be paid in the second year?

Accepted Answer

To find the indexed wage in year two, the wage that would maintain the purchasing power from the first year, take the nominal wage in year one and multiply it by the CPI:, $10 × 1.07 = $10.70. Then, since the contract calls for an increase in the real wage by 3%, the indexed wage must be increased by 3 percent: $10.70 × 1.03 = $11.02.

Question 20

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.

Quiz 5: Measuring Economic Activity: GDP, Unemployment, and Inflation

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 ___.