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Extending the Text
The exercise below provides additional practice with measuring the CPI and using year-to-year changes in the CPI to measure the rate of inflation.
Note: Prices must range between $0.00 and $900.00 Quantities range between 0 and 100 units
The interactive pop-up lists the monthly expenditures for a "typical" household budget that includes four items: rent on a two-bedroom apartment, 60 hamburgers, 10 movie tickets, and 40 candles, over a two-year period. Note that the price of candles fell from 2001 to 2002, while the prices of the other three goods rose.
Compute the consumer price index for each year (using 2001 as the base year) and calculate the rate of inflation faced by this family based on this CPI.
Now, assume that the price of candles remained the same from 2001 to 2002 (i.e. change the price of candles in 2002 to $1.50). Recompute the consumer price index for each year (again using 2001 as the base year) and calculate the rate of inflation based on this CPI. Compare your answers in the two cases.
To begin, reset the interactive pop-up to its initial values by clicking on the Reset button. Now, assume that this "typical" family responds to the price changes in 2002 by reducing its purchases of hamburgers (to 50 hamburgers per month) and movie tickets (to 8 movies per month), while increasing its purchase of candles (to 50 per month). What is the "true" (percentage) change in the cost of living for this family after these spending changes? According to the CPI, what is the change in the cost of living for this family? What do you conclude about the CPI, in terms of its ability to measure "true" inflation?
Suppose this family's income rose from $50,000 in 2001 to $54,000 in 2002. Is this family better off or worse off in 2002, according to the CPI (using 2001 as the base year)? How much would this family's income need to increase from 2001 to 2002 to maintain its purchasing power between the two years?
