Q: Suppose the cost of the CPI basket in the base year (2023) is $$80, and in 2024 it is 100. $$What is the CPI for 2024?

$$CPI_{2024} = 100 \times \frac{100}{80} = 125$$

Q: If the CPI in 2024 is 125 and the CPI in 2025 is 140, what is the inflation rate from 2024 to 2025?

$$\text{Inflation Rate} = \frac{140 - 125}{125} \times 100 = 12\%$$

Q: Suppose the nominal interest rate on a savings account is 8% and the inflation rate is 3%. What is the real interest rate?

$$\text{Real Interest Rate} = 8\% - 3\% = 5\%$$

Q: If the CPI in 1964 was 31.0 and the CPI in 2024 is 313.7, what is the value in 2024 dollars of a $1.15 minimum wage in 1964?

$$1.15 \times \frac{313.7}{31.0} = 11.64$

Question 1

Which of the following best describes the purpose of the Consumer Price Index (CPI)?

Accepted Answer

To measure the typical consumer's cost of living by tracking changes in the price of a fixed basket of goods and services.

Question 2

Suppose the cost of the CPI basket in the base year (2023) is $$80, and in 2024 it is 100. $$What is the CPI for 2024?

Accepted Answer

$$CPI_{2024} = 100 	imes \frac{100}{80} = 125$$

Question 3

If the CPI in 2024 is 125 and the CPI in 2025 is 140, what is the inflation rate from 2024 to 2025?

Accepted Answer

$$	ext{Inflation Rate} = \frac{140 - 125}{125} 	imes 100 = 12\%$$

Question 4

Which of the following is NOT included in the CPI basket?

Accepted Answer

Capital goods produced domestically

Question 5

A major problem with the CPI is substitution bias. What does this mean?

Accepted Answer

The CPI overstates the true increase in the cost of living because it uses a fixed basket and misses consumers substituting toward relatively cheaper goods.

Question 6

If the price of imported Italian jeans rises, which price index is affected?

Accepted Answer

Only the CPI

Question 7

Suppose the nominal interest rate on a savings account is 8% and the inflation rate is 3%. What is the real interest rate?

Accepted Answer

$$	ext{Real Interest Rate} = 8\% - 3\% = 5\%$$

Question 8

Which of the following scenarios would cause the GDP deflator to increase but not the CPI?

Accepted Answer

A U.S. company raises the price of industrial tractors produced domestically.

Question 9

Why does the introduction of new goods cause the CPI to overstate the true increase in the cost of living?

Accepted Answer

The CPI uses a fixed basket and does not account for increased variety and better matching of consumer preferences, making each dollar more valuable.

Question 10

If the CPI in 1964 was 31.0 and the CPI in 2024 is 313.7, what is the value in 2024 dollars of a $1.15 minimum wage in 1964?

Accepted Answer

$$1.15 	imes \frac{313.7}{31.0} = 11.64$

Question 11

Which of the following is a limitation of the CPI when accounting for quality changes?

Accepted Answer

Quality improvements are difficult to measure, so the CPI may overstate the true increase in the cost of living.

Question 12

A student wants to compare the real increase in tuition costs between 1990 and 2024. Which formula should they use to convert 1990 tuition to 2024 dollars?

Accepted Answer

$$	ext{Amount in 2024 dollars} = 	ext{Amount in 1990 dollars} 	imes \frac{CPI_{2024}}{CPI_{1990}}$$

Question 13

Which component makes up the largest share of the CPI basket?

Accepted Answer

Housing

Question 14

If the cost of the CPI basket in 2023 is $$80, in 2024 is 100$$, and in 2025 is $120, what is the inflation rate from 2024 to 2025?

Accepted Answer

$$	ext{CPI}_{2024} = 100 	imes \frac{100}{80} = 125$$; $$	ext{CPI}_{2025} = 100 	imes \frac{120}{80} = 150$$; $$	ext{Inflation Rate} = \frac{150 - 125}{125} 	imes 100 = 20\%$$

Question 15

Which of the following would cause the CPI to overstate the true increase in the cost of living?

Accepted Answer

Consumers substitute toward goods that become relatively cheaper, but the CPI uses a fixed basket.

Question 16

If the nominal interest rate is 6% and the inflation rate is 7%, what happens to the purchasing power of money deposited in a bank?

Accepted Answer

Purchasing power decreases because the real interest rate is negative: $$6\% - 7\% = -1\%$$

Question 17

Which of the following is true about the GDP deflator compared to the CPI?

Accepted Answer

The GDP deflator includes capital goods produced domestically, while the CPI does not.

Question 18

A household changes its consumption from 10 lbs. beef and 20 lbs. chicken in 2023 to 5 lbs. beef and 25 lbs. chicken in 2025 because chicken became relatively cheaper. What CPI problem does this illustrate?

Accepted Answer

Substitution bias

Question 19

If the CPI basket cost $$80 in 2023 (base year), 100 in 2024$$, and $120 in 2025, what is the percentage increase in the cost of the basket from 2024 to 2025?

Accepted Answer

$$\frac{120 - 100}{100} 	imes 100 = 20\%$$

Measuring the Cost of Living: The Consumer Price Index (CPI) and Inflation

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