Eco 302 Name_______________________________

Problem Set 2x 16 February 2011

Answer Key
1. The following table shows the prices and quantities of the typical market basket of goods
consumed in an economy. The base year is 2008.

Year Price of Quantity of Quantity of Quantity of Quantity of Quantity of

Diet Coke Diet Coke Butterfinger Butterfinger Cell Phone Cell Phone
Crisp Bars Crisp Bars Service Services
2008 1.00 30 0.50 60 20.00 12
2009 1.20 25 0.55 50 30.00 12
2010 1.25 20 0.60 40 40.00 12
.
Compute the cost of the fixed basket in each year.

Cost of Basket
2008 $300.00
2009 $429.00
2010 $553.50

Make 2008 the base year and convert to calculate CPI.

2008 100
2009 143.00
2010 184.50

Inflation in 2009 = 43.0

Inflation in 2010 = 29.02

2. Suppose the residents of Terrierville spend all of their income on hamburgers, french fries,
and cokes. In 2008 they bought 100 burgers for $200, 50 french fries for $75, and 500 cokes for
$500. In 2009 they bought 75 burgers for $225, 80 french fries for $120, and 500 cokes for
$550? If the base year is 2008, what is the CPI in both years? What is the inflation rate in 2009?

To find the percentage change in the overall price level, follow these steps:
a. Determine the fixed basket of goods: 100 burgers, 50 fries, 500 cokes.
b. Find the price of each good in each year:
Year Burgers French Fries Cokes
2008 $2 $1.50 $1
2009 $3 $1.50 $1.10
c. Compute the cost of the basket of goods in each year:
2008: (100 x $2) + (50 x $1.50) + (500 x $1) = $775
2009: (100 x $3) + (50 x $1.50) + (500 x $1.10) = $925

d. Choose one year as a base year (2001) and compute the CPI in each year:
2008: $775/$775 x 100 = 100
2009: $925/$775 x 100 = 119

e. Use the CPI to compute the inflation rate from the previous year:
Inflation in 2009 = (119 - 100)/100 x 100 = 19%

3. Over a period of time, the price of a candy bar rose from $0.10 to $0.60. Over the same
period, the consumer price index rose from 150 to 300. Adjusted for overall inflation, how much
did the price of the candy bar change?

Since the overall price level has doubled, but the price of the candy bar rose sixfold,
the real price (the price adjusted for inflation) of the candy bar has tripled.

Original price of candy bar adjusted to today = $0.10 × (300/150) = $0.20

Use this number to calculate the real increase in the price of the candy bar:
Change in real price of candy bar = [$0.60 - $0.20]/$0.20 = 200%

4. Suppose the residents of Veggieland spend all of their income on cauliflower, broccoli, and
carrots. In 2008 they buy 100 heads of cauliflower for $200, 50 bunches of broccoli for $75, and
500 carrots for $50. In 2009 they buy 75 heads of cauliflower for $225, 80 bunches of broccoli
for $120, and 500 carrots for $100. If the base year is 2008, what is the CPI in both years? What
is the inflation rate in 2009?

To find the percentage change in the overall price level, follow these steps:
a. Determine the fixed basket of goods: 100 heads of cauliflower, 50 bunches of
broccoli, 500 carrots.

b. Find the price of each good in each year:

Year Cauliflower Broccoli Carrots
2008 $2 $1.50 $0.10
2009 $3 $1.50 $0.20

c. Compute the cost of the basket of goods in each year:

2008: (100 x $2) + (50 x $1.50) + (500 x $.10) = $325

2009: (100 x $3) + (50 x $1.50) + (500 x $.20) = $475

d. Choose one year as a base year (2008) and compute the CPI in each year:
2008: $325/$325 x 100 = 100
2009: $475/$325 x 100 = 146

e. Use the CPI to compute the inflation rate from the previous year:
 Inflation Rate in 2009 = (146 - 100)/100 x 100 = 46%

5. Your instructor started a job on 1 March 1973. The job paid $1.85 per hour at the time when
the minimum wage was $1.60. The CPI for March 1973 is 43.3. The CPI for December 2010 is
219.179.

What is the 1973 wage in December 2010 dollars?

Wage in 2010 = Wage in 1973 x (219.179/43.3) = $1.85(5.06) = $9.36
What is the 1973 minimum wage in December 2010 dollars?
Wage in 2010 = Wage in 1973 x (219.179/43.3) = $1.60(5.06) = $8.09

6. On 1 January 1976, the minimum wage was raised to $2.30. The CPI for January 1976 is
55.6. The CPI for December 2010 is 219.179. .
What is the 1976 minimum wage in December 2010 dollars?
Wage in 2010 = Wage in 1976 x (219.179/55.6) = $9.07

7. Your instructor worked the summer of 1976. He earned $5.65 per hour. Working the
graveyard shift (midnight – 8:00am) he earned time-and-a-half. The CPI for July 1976 is 57.1.
The CPI for December 2010 is 219.179. .
What is the summer 1976 day-time wage in December 2010 dollars?
Wage in 2010 = Wage in 1976 x (219.179/57.1) = $21.69
What is the summer 1976 night-time wage in December 2010 dollars?
Wage in 2010 = Wage in 1976 x (219.179/57.1) = $32.53

8. The Buick B-25 sold for $1, 050 in 1914. The CPI for July 1914 is 10.0 (1982-84=100).
Calculate the price of the Buick in December 2010 dollars. The CPI for December 2010 is
219.179. .
Price in 2010 = Price in 1914 x (219.179/10.0) = $23,014

9. Your instructor could have applied for a summer research grant in 1991, but chose to teach
two courses. The research grant would have paid $3,000. Last summer, professors who were
awarded research grants received $4,000. How much would the research grant need to be to have
the same purchasing power as the grant in 1991? The CPI for June 1991 is 136.0. The CPI for
December 2010 is 219.179.

Value of 1991 Grant in 2010 dollars = Value in 1991 x (219.179/136.0) = $4834.83