Chapter 24/Measuring the Cost of Living 141
Measuring the Cost of Living
Which price index measures the average price of things purchased by the typical family in an
a. GDP deflator
b. producer price index
c. consumer price index
d. minimum wage
Which item would receive the most weight in the consumer price index?
Which item would receive the least weight in the consumer price index?
c. color televisions
d. automobile tires
The good that receives the most weight in the CPI is the good that
a. consumers buy most frequently.
142 Chapter 24/Measuring the Cost of Living
b. has experienced the greatest price increase.
c. has the highest price.
d. consumers spend the largest fraction of their income on.
Which of the following is a reason why the Consumer Price Index (CPI) is not calculated as a
simple average of all prices?
a. Some goods experience large price changes and the CPI would be too variable if computed by a
b. Goods differ in their importance in the average consumer’s budget.
c. Some goods never experience price changes and the CPI would not be variable enough if
computed as a simple average.
d. It would be difficult to compute a price index using a simple average of all prices.
If the price of the market basket of goods in the base year of 1994 was $20,000 and the price of the
same basket had risen to $22,000 by 1998, the CPI for 1998
a. cannot be calculated.
b. is $12,000.
c. is 200.
d. is 110.
Suppose you spend 30 percent of your budget on food, 20 percent on medical care, 40 percent on
rent, 5 percent on entertainment, and 5 percent on miscellaneous items. If the price of all parts of
your budget rises equally in percentage terms, which would have the most weight on your cost of
living increase? (Assume you calculate your index the same way the CPI is calculated.)
b. medical care
a. is one factor that causes the CPI to underestimate the inflation rate.
b. is caused by the poor quality of many imported products.
Chapter 24/Measuring the Cost of Living 143
c. is one of the primary causes of inflation.
d. involves consumer behavior that helps explain why the CPI overestimates the inflation rate.
Improvements in the quality of consumer goods and services over time
a. cause the CPI to overstate actual inflation.
b. cause the CPI to understate actual inflation.
c. are accounted for in the CPI.
d. are insignificant and thus would not affect the CPI even if accounted for.
Factors that cause the CPI to exaggerate the inflation rate do not include
a. the tendency of consumers to substitute relatively cheaper goods for those that have become
relatively more expensive.
b. political pressure from unions and retirees on the Bureau of Labor Statistics to overstate the
c. the introduction of new technologies that make it easier to obtain the same standard of living.
d. improvements over time on the quality of products.
Which of the following answers would accurately describe the bias in the CPI resulting from the
fact that oil prices suddenly increase?
a. underestimate the cost of living
b. overestimate the cost of living
c. have no bias effect on the CPI
d. could overestimate or underestimate the cost of living, depending upon the quantity of oil
purchased in that year
The CPI differs from the GDP deflator in that the CPI includes
a. raw material prices whereas the GDP deflator does not.
b. only goods whereas the GDP deflator includes both goods and services.
c. only services whereas the GDP deflator includes both goods and services.
144 Chapter 24/Measuring the Cost of Living
d. only items the typical household buys, whereas the GDP deflator includes all goods and
services produced in the economy.
The CPI differs from the GDP deflator in that the CPI
a. uses baseyear quantities of goods to weight prices.
b. uses currentyear quantities of goods to weight prices.
c. is not a weighted price index.
d. always indicates a higher rate of inflation than the GDP deflator.
The GDP deflator differs from the CPI because the GDP deflator includes goods we __________,
while the CPI includes goods we __________.
a. import; export
b. export; import
c. buy; sell
d. consume; produce
If the consumer price index has a value of 150 today and the base year is 1987, then consumer
a. increased by 50 percent since 1987.
b. doubled since 1987.
c. more than doubled since 1987.
d. declined 50 percent since 1987.
If the consumer price index has a value of 150 today and the base year is 1987, then it costs
a. $100 today to buy what cost $150 in the base year.
b. $1 today to buy what cost $150 in the base year.
c. $150 today to buy what cost $100 in the base year.
d. $2 today to buy what cost $1 in the base year.
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Use this table to find the real wage in 2002.
Nominal Wage ($/Hour)
If the CPI increases from 100 to 200 and the nominal wage increases from $100 to $400, what is the
change in the real wage in terms of the beginning year’s dollars?
The real interest rate on a loan
a. is the amount that the consumer agrees to pay.
b. is always the same as the nominal rate.
c. is the percentage increase in the lender’s purchasing power that results from making the
d. decreases as the inflation rate increases.
If a lender wants a real return of 6 percent and she expects inflation to be 4 percent, which of the
following is the nominal interest rate to charge?
a. 4 percent
b. 6 percent
146 Chapter 24/Measuring the Cost of Living
c. 2 percent
d. 10 percent
Suppose that a labor union leader is trying to bargain for an increase in union workers’ real wages
of 5 percent. If she expected the price level to rise at a rate of 3 percent this year, how much would
nominal wages need to increase for her to accomplish her objective?
a. 2 percent
b. 3 percent
c. 5 percent
d. 8 percent
When borrowing money to purchase an automobile, Wei has the choice between a fixed nominal
interest rate or adjustable nominal interest rate loan. Typically the adjustable rate loans start with a
lower rate than the fixed rate loans. Given that, Wei would most likely want to borrow money at
the higher fixed rate when she expects the
a. inflation rate to rise.
b. inflation rate to fall.
c. inflation rate to remain unchanged.
d. government to take action to lower the inflation rate in the near future.
If you borrow money at a nominal interest rate of 5 percent and the inflation rate is 10 percent,
what real interest rate will you pay?
a. –5 percent
b. .5 percent
c. 2 percent
d. 10 percent
When the inflation rate ends up being lower than expected,
a. everyone benefits because money is cheaper.
b. everyone benefits because prices do not increase.
c. lenders of fixedrate mortgages generally benefit because they will make higher profits than
they had calculated.
d. borrowers with fixedrate loans will benefit because their purchasing power will not decline
In general, a higherthananticipated inflation rate
a. helps everyone.
b. hurts everyone.
c. helps creditors and harms debtors.
d. helps debtors and harms creditors.