Question 1

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, as consumers must pay the same price for a lesser quality product. If this change in quality is not accounted for in the CPI, it will lead to an understatement of the change in the cost of living. Therefore, choice D is the best answer.

Question 2

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 3

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 in the construction of the CPI because consumers are substituting a cheaper alternative (steel studs) for a more expensive one (wooden studs) as a result of the increase in the price of lumber. The CPI assumes that consumers always purchase the same basket of goods, but this situation shows that they may switch to different goods in response to changing prices.

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

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

Accepted Answer

The creation of the mobile phone is most relevant to the problem of introduction of new goods in the construction of the CPI. When a new product is introduced, it can be difficult to determine how it should be included in the index and how it affects the inflation rate. The mobile phone is a good example of this problem, as it did not exist when the CPI was first developed and its impact on inflation has been significant.

Question 6

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

This situation is most relevant to substitution bias because Samantha substituted ginger ale with peppermint tea due to the increase in the price of ginger ale. Substitution bias occurs when consumers substitute cheaper goods for more expensive ones, leading to a potential overestimation of the inflation rate if the CPI does not account for this substitution.

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

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 are likely to buy less of that good and more of its substitutes, which are relatively cheaper. This is the law of demand, which states that as the price of a good increases, the quantity demanded of that good decreases, ceteris paribus.

Question 9

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 size and materials used for making golf club drivers is a classic example of unmeasured quality change in the construction of the CPI. If the Bureau of Labor Statistics does not make adjustments for these changes, it may overestimate the rate of inflation. This is because an increase in the price of golf club drivers may reflect not just an increase in the cost of production, but also an improvement in the quality of the product. Therefore, it is important to account for these quality improvements when measuring inflation.

Question 10

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 falls under the problem of introduction of new goods in the construction of the CPI. These new goods can be difficult to include accurately in the price index, leading to underestimation of the rate of inflation.

Question 11

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. If dairy products have risen in price less than prices in general, consumers may shift their consumption patterns towards dairy products and away from other goods, leading to an overstatement of the CPI. Substitution bias occurs because the CPI assumes that consumers continue to purchase the same basket of goods over time, even as relative prices change, without considering that consumers may substitute towards goods that have become relatively cheaper.

Question 12

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 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 situation represents unmeasured quality change because the price of the software remained the same, but the quality improved with the upgraded version. This change in quality is not reflected in the CPI, which can lead to inaccuracies in measuring the true cost of living.

Question 14

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

An increase in the CPI means a decrease in the purchasing power of money, essentially meaning that people's incomes have not kept up with the increase in prices. Therefore, people are likely to buy less of both goods, including less milk and fewer T-shirts.

Question 15

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 16

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 17

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

Statistics Canada should decrease the CPI because the improvement in quality effectively reduces the cost of living, as consumers get more value for the same price, which is akin to a price reduction.

Question 18

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 19

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, which can have a significant impact on individuals and the economy as a whole. If the CPI is not accurately measuring the cost of living, it could lead to improper adjustments and unintended consequences.

Question 20

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

Accepted Answer

There is still debate among economists on the severity of the CPI bias and what to do about it. While there is general agreement among economists that there is bias in the CPI, there is still ongoing discussion and debate about the exact extent of the bias and how best to address it.

Quiz 6: Measuring the Cost of Living