MACROECONOMICS CHAPTER 11 CPI TEST QUESTIONS AND ANSWERS

what is the Consumer Price Index? - ANSWER Measures the typical
consumer's cost of living

How is CPI calculated - ANSWER 1. fix the basket
2. find the prices of goods in the basket
3. use prices to compute the total cost of the basket
4. choose a base year and compute index
5. calculate inflation rate

Base year index equation - ANSWER 100 x
(cost of basket in current year/ cost of basket in base year)

Inflation equation - ANSWER [(CPI this year - CPI last year)/(CPI last year)]
x 100

What are the problems with CPI - ANSWER -substitution bias
-introduction to new goods
-unmeasured quality change

What is the effect of the problems with CPI - ANSWER they cause CPI to
overstate the cost of living

what is the seriousness of the CPI problems - ANSWER Social security
payments and other contracts have COLAS tied to CPI

Substitution Bias (problem with CPI) - ANSWER -consumers migrate towards
lower prices
-CPI doesn't work because of fixed basket of goods

Introduction to new goods (problem with CPI) - ANSWER allows more
variety, which allows needs to be better met