Question 1

Which problem 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 most relevant to the problem of introduction of new goods, as it represents a new product category that did not exist in the past and was not previously included in the CPI calculations. This can lead to an underestimate of the true inflation rate if the introduction of new goods is not properly accounted for in the CPI.

Question 2

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 problem in the construction of the CPI is this situation most relevant to?

Accepted Answer

The situation is most relevant to substitution bias, as Samantha decided to buy a different good (peppermint tea) due to the price increase of ginger ale. This substitution is not accounted for in the calculation of CPI, which assumes consumers continue buying the same goods regardless of price changes.

Question 3

What does the GDP deflator reflect?

Accepted Answer

The GDP deflator is a measure of the level of prices in the current year relative to the level of prices in the base year. It is calculated by dividing nominal GDP by real GDP and multiplying by 100. The resulting number reflects the level of inflation or deflation in the economy since the base year.

Question 4

In recent years, there have been increases in the size of golf club drivers and the methods and materials used for making them have improved. Which problem in the construction of the CPI is this change in drivers most relevant to?

Accepted Answer

The change in golf club drivers is most relevant to unmeasured quality change, as the improvements in materials and methods used for making them represent changes in the quality of the product that are not reflected in the CPI.

Question 5

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 problem in the construction of the CPI would this situation represent, respectively?

Accepted Answer

The situation represents substitution bias because consumers would likely switch from gasoline to hydrogen fuel due to the price increase, and the introduction of new goods because the hydrogen-powered engine is a new product that wasn't previously considered in the market basket of goods.

Question 6

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 answer of Research done at the Bank of Canada...

Question 7

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 8

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 introduction of new goods and services increases consumer choice and allows for substitution towards these new options, which can be more cost-effective or provide better value, thus potentially reducing the overall cost of maintaining a certain standard of living. The CPI, by focusing on a fixed basket of goods, may not account for this substitution effect adequately, leading to an overestimation of the cost of living.

Question 9

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

Accepted Answer

When the relative price of a good increases, consumers will shift their demand towards substitute goods which are relatively cheaper. As a result, consumers will buy less of the relatively expensive good and more of its substitutes.

Question 10

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

Accepted Answer

This situation represents substitution bias because consumers are substituting one product (wooden studs) for another (steel studs) due to a change in relative prices. The CPI may not fully account for this substitution and therefore overstate the price increase for housing construction.

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...

Question 12

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

Accepted Answer

While there is some agreement among economists that the CPI has bias as a measure of the cost of living, there is still debate over how severe this bias is and what should be done to address it.

Question 13

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 problem in the construction of the CPI does this situation best represent?

Accepted Answer

The answer of Laura bought word processing software for $50....

Question 14

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 15

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

Accepted Answer

This price increase is most relevant to substitution bias. Substitution bias occurs when consumers substitute cheaper goods for more expensive ones, which is not fully accounted for in the CPI. If dairy products have risen in price less than other goods, consumers may be more likely to buy dairy products instead of other goods, leading to an overestimate of inflation if this substitution is not reflected in the CPI.

Question 16

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

Accepted Answer

The introduction of new goods, such as the mobile phone, can create issues in the construction of CPI. The mobile phone could not have been included in the CPI when it was first introduced, and therefore, the increase in quality and decrease in price over time may not be accurately reflected in the index. This can lead to an overestimate of inflation. Substitution bias refers to consumers switching to cheaper goods when prices of certain goods increase, unmeasured quality change refers to changes in quality that are not accounted for in the index, and income bias refers to changes in consumer spending patterns due to changes in income.

Question 17

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

Accepted Answer

Many businesses and government programs use the CPI to make adjustments to wages and benefit payments, making it important to have accurate measurements.

Question 18

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 that the dollar can buy less of the good. If this change in quality is not accounted for in the CPI, the index will underestimate the increase in the cost of living because it does not fully reflect the decrease in purchasing power.

Question 19

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

The rise in CPI indicates a general increase in prices of goods and services, which means people will have to spend more money on their purchases. Since the prices of both milk and T-shirts have increased, people are likely to reduce their consumption of both items, resulting in less milk and fewer T-shirts purchased.

Question 20

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.

Quiz 6: Measuring the Cost of Living