In Felixania,cat food constitutes 45% of the typical basket of goods for a typical consumer,dog food constitutes 3%,and all other goods constitute the remaining 52%.Assume the price of cat food rises by 4%,the price of dog food falls by 10%,and the prices for all other goods remain constant.Based on the information given,we can definitely say:
A) because all consumers are the same, all consumers must be worse off as a result of the change.
B) because the goods included in the consumer price index (CPI) necessarily change from year to year, we can't determine the value of the new CPI.
C) if consumers get a 4% pay raise, they are worse off in terms of their real income compared to inflation as measured by the Felixanian CPI.
D) if consumers get at 4% pay raise, they are better off in terms of their real income compared to inflation as measured by the Felixanian CPI.
E) menu costs have decreased.

Question

Quizplus · Accepted Answer

Since cat food has a higher weight in the typical basket of goods, the overall impact of the 4% increase in its price will be greater than the 10% decrease in the price of dog food. Therefore, the overall price level would increase, making consumers worse off. However, if consumers receive a 4% pay raise, their real income will increase by the same amount, which means they are better off in terms of their purchasing power. The information provided does not give any indication of changes in the goods included in the CPI or menu costs, so options B and E are not relevant. Option A is incorrect because the impact of the price changes differs across goods and consumers, so it's not necessarily the case that all consumers will be worse off. Option C is incorrect because a 4% pay raise would offset the impact of the price increase on cat food, so consumers would not be worse off compared to inflation.

In Felixania,cat Food Constitutes 45% of the Typical Basket of Goods