Chapter 23

Measuring the Cost of Living

MULTIPLE CHOICE (1-29)

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1
. Babe Ruth, the famous baseball player, earned $80,000 in 1931. Today, the best baseball
players can earn 100 times as much as did Babe Ruth in 1931. However, prices have also
risen since 1931. We can conclude that
a. the best baseball players today are about 100 times better off than Babe Ruth was in
1931.
b. because prices have also risen, the standard of living of baseball stars hasn’t changed
since 1931.
c. one cannot make judgements about changes in the standard of living based on changes
in prices and changes in incomes.
d. one cannot determine whether baseball stars today enjoy a higher standard of living
than Babe Ruth did in 1931 without additional information regarding increases in
prices since 1931.

2
. The statistic used to convert dollar amounts into meaningful measures of purchasing power
is called
a. the GDP deflator.
b. the wholesale price index.
c. the consumer price index.
d. the producer price index.

3
. When the consumer price index rises, the typical family
a. has to spend more dollars to maintain the same standard of living.
b. can spend fewer dollars to maintain the same standard of living.
c. finds that its standard of living is not affected.
d. can offset the rising prices by saving more.

4
. The consumer price index is used to
a. track changes in the level of wholesale prices in the economy.
b. monitor changes in the cost of living.
c. monitor changes in the level of real GDP.
d. track changes in the stock market.

5
. The term inflation is used to describe a situation in which
a. incomes in the economy are increasing.
b. stock market prices are rising.
c. the economy is growing rapidly.
d. the overall level of prices in the economy is increasing.

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6
. When the overall level of prices in the economy is increasing, we say that the economy is
experiencing
a. economic growth.
b. inflation.
c. unemployment.
d. deflation.
7
. The inflation rate is defined as
a. the cost of inflation.
b. the rate which must be paid for borrowing.
c. the percentage change in the price level from the previous period.
d. the percentage change in output from the previous period.
8
. The inflation rate is
a. a key variable in guiding macroeconomic policy.
b. a closely watched aspect of macroeconomic performance.
c. interesting from the standpoint of individual households, but of little interest to
policymakers.
d. Answers a and b are both correct.TYPE: M SECTION: INT OBJECTIVE:
RANDOM: Y
9
. The CPI is a measure of
a. the overall cost of goods and services bought by a typical consumer.
b. the overall cost of inputs purchased by a typical producer.
c. the overall cost of goods and services produced in the economy.
d. the overall cost of stocks on the New York Stock Exchange.

10
. The CPI is calculated by which of the following agencies?
a. the National Price Board
b. the Internal Revenue Service
c. the Bureau of Labor Statistics
d. the Congressional Budget Office SECTION: 1 OBJECTIVE: 1 RANDOM: Y
11
. The CPI is calculated
a. weekly.
b. monthly.
c. quarterly.
d. yearly.

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12
. What is the basket of goods used to construct the CPI?
a. A random sample of all goods and services produced in the economy.
b. The goods and services determined by the American Medical Association to be most
healthy.
c. The goods and services typically bought by consumers, according to Bureau of Labor
Statistics surveys.
d. the least expensive goods and services in each major category of consumer
expenditures.
13
. When constructing the CPI, the Bureau of Labor Statistics tries to include
a. all goods and services produced in the economy.
b. all goods and services purchased in the economy.
c. all goods and services that typical consumers buy.
d. The Bureau of Labor Statistics does not construct the CPI.

14
. In the CPI, goods and services are weighted according to
a. whether the goods and services are necessities or luxuries.
b. the levels of production of the goods and services in the domestic economy.
c. a random weighting scheme.
d. how much consumers buy of each item.

15
. How are the weights on the various goods and services in the CPI basket determined?
a. All goods and services are weighted equally.
b. A survey is conducted to determine how much of each good and service typical
consumers purchase.
c. Each good and service is weighted according to its price.
d. Weights are randomly assigned.

16
. The steps involved in calculating the consumer price index include, in order:
a. fix the basket, find the prices, compute the basket’s cost, choose a base year and
compute the index, compute the inflation rate
b. choose a base year, find the prices, fix the basket, compute the basket’s cost, compute
the index and the inflation rate
c. fix the basket, find the prices, compute the inflation rate, choose a base year and
compute the index
d. choose a base year, fix the basket, compute the inflation rate, compute the basket’s cost
and compute the index

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17
. In the CPI, the base year is
a. the benchmark against which other years are compared, updated each year.
b. the benchmark against which other years are compared.
c. a particularly bad year for consumer prices.
d. always 1989.

18
. For any given year, the CPI is
a. the price of the basket of goods and services in the base year divided by the price of
the basket in the given year, then divided by 100.
b. higher than the previous year.
c. the price of the basket of goods and services in the base year divided by the price of the
basket in the given year, then multiplied by 100.
d. the price of the basket of goods and services in the given year divided by the price of
the basket in the base year, then multiplied by 100.
19
. By far the largest category of goods and services in the CPI basket is
a. food and beverages.
b. transportation.
c. housing.
d. recreation
20
. Categories of U.S. consumer spending, ranked from largest to smallest are:
a. food and beverages, housing, transportation, and medical care.
b. housing, transportation, food and beverages, and medical care.
c. medical care, housing, food and beverages, and transportation.
d. housing, food and beverages, transportation, and medical care.
21
. About what percentage of U.S. consumer spending does food and drink make up?
a. 6 percent
b. 16 percent
c. 4 percent

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d. 40 percent
22
. Which of the following makes up the smallest category of consumer spending in the U.S.?
a. housing
b. apparel
c. food and beverages
d. transportation

23
. In U.S. consumer spending, housing makes up _____% of the total, food and beverages
make up _____% of the total, and transportation makes up _____% of the total.
a. 50, 26, 27
b. 40, 16, 17
c. 17, 40, 16
d. 50, 17, 16
24
. If the cost of housing increases by 20 percent, the CPI is likely to increase by

22

?
~ANSWER:
b. apparel
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

23

?
~ANSWER:

b. 40, 16, 17

24

?
~ANSWER:
d. about 8 percent.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

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a. about 20 percent.
b. about 40 percent.
c. about 17 percent.
d. about 8 percent.
25
. If the cost of medical care increases by 50 percent, the CPI is likely to increase by
a. about 3 percent.
b. about 6 percent.
c. about 30 percent.
d. about 40 percent.
26
. If the cost of transportation and the cost of food and beverages increase by 30 percent, the
CPI is likely to increase by
a. about 30 percent.
b. about 10 percent.
c. about 3 percent.
d. about 33 percent.
27
. If the CPI increases from one year to the next, the economy has experienced
a. stagnation.
b. stagflation.
c. inflation.
d. growth.
28
. The inflation rate is calculated by
a. a survey of consumer spending.
b. adding up the price increases of all goods and services.
c. determining the percentage increase in the price index from the preceding period.
d. averaging the increases in the output of all consumer goods and services.

29
. If the consumer price index was 100 in the base year and 105 the following year, the
inflation rate was
a. 105 percent.
b. 100 percent.
c. 10.5 percent.
d. 5 percent.

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30
. If the price index in the first year was 90, in the second year was 100, and in the third year
was 95,
a. the economy experienced 10 percent inflation between the first and second years and 5
percent inflation between the second and third years.
b. the economy experienced 10 percent inflation between the first and second years and 5
percent deflation between the second and third years.
c. the economy experienced 11 percent inflation between the first and second years and 5
percent inflation between the second and third years.
d. the economy experienced 11 percent inflation between the first and second years and 5
percent deflation between the second and third years.

31
. The price index in 2001 is 120, and in 2002 the price index is 126. What is the inflation
rate?
a. 5 percent
b. 6 percent
c. 26 percent
d. The inflation rate is impossible to determine without knowing the base year.

32
. The price index in the first year is 100, in the second year is 90, and in the third year is 80.
What is the deflation rate between the first and second year, and between the second and
third year?
a. 10 percent between the first and second year, 20 percent between the second and third
year
b. 10 percent between the first and second year, 11 percent between the second and third
year
c. 11 percent between the first and second year, 12 percent between the second and third
year
d. 11 percent between the first and second year, 22 percent between the second and third
year

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33
. The price index in the first year is 125, in the second year is 150, and in the third year is
200. What is the inflation rate between the first and second year and between the second
and third year?
a. 20 percent between the first and second year, 33 percent between the second and third
year
b. 50 percent between the first and second year, 100 percent between the second and third
year
c. 25 percent between the first and second year, 75 percent between the second and third
year
d. 25 percent between the first and second year, 50 percent between the second and third
year

34
. Which change in the price index shows the greatest rate of inflation: 100 to 110, 150 to 165,
or 180 to 198?
a. 100 to 110
b. 150 to 165
c. 180 to 198
d. All changes show the same rate of inflation.
35
. Which change in the price index shows the greatest rate of inflation: 80 to 96, 100 to 125,
or 150 to 180?
a. 80 to 96
b. 100 to 125
c. 150 to 180
d. All changes show the same rate of inflation.

36
. Which change in the price index shows the greatest rate of deflation?
a. 150 to 120
b. 120 to 100
c. 100 to 90
d. 100 to 150
37
. Which of the following changes in the price index shows the greatest rate of inflation or
deflation?

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a. 120 to 100
b. 100 to 120
c. 120 to 140
d. All of the above changes show the same rate of change.
38
. About how many goods and services are included in the basket which forms the basis for
the consumer price index?
a. millions
b. thousands
c. hundreds
d. fewer than 100
39
. The producer price index measures
a. the cost of a basket of goods and services sold by producers.
b. the cost of a basket of goods and services bought by firms.
c. the cost of a basket of goods and services typical of those produced in the economy.
d. the cost of a basket of goods and services produced for a typical consumer.
40
. Changes in the producer price index are often thought to be useful in predicting
a. changes in consumer confidence.
b. changes in the rate of output of goods and services.
c. changes in the stock price index.
d. changes in the consumer price index.
41
. Suppose than in 2002, the producer price index increases by 7 percent. As a result,
economists most likely will predict that
a. GDP will increase by 7 percent in the next year.
b. the consumer price index will increase by 7 percent in the next year.
c. the exchange rate will increase in the future.
d. the consumer price index will increase in the future.
42
. The goal of the consumer price index is
a. to measure changes in GDP.
b. to measure changes in the cost of living.
c. to measure changes in the cost of doing business.
d. to measure changes in the production of consumer goods.

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43
. Which of the following is the most accurate statement about the CPI as a measure of the
cost of living?
a. The CPI is not a perfect measure of the cost of living.
b. The CPI is useless as a measure of the cost of living.
c. The CPI is a perfect measure of the cost of living.
d. There are ten major problems that make the CPI of little use as a measure of the cost of
living.

44
. The consumer price index
a. is not very useful as a measure of the cost of living.
b. is a perfect measure of the cost of living.
c. is not used as a measure of the cost of living.
d. is not a perfect measure of the cost of living.
45
. Which of the following is not a widely-acknowledged problem with the CPI as a measure
of the cost of living?
a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. unmeasured price change
e. All of the above are problems with the CPI.
46
. The substitution bias in the consumer price index refers to
a. the substitution of new goods for old goods in the purchases of consumers.
b. the fact that consumers substitute toward goods that have become relatively less
expensive.
c. the substitution of new prices for old prices in the basket of goods from one year to the
next.
d. the substitution of quality for quantity in consumer purchases over time.
47
. When prices change from year to year,
a. they all change proportionately.
b. they always increase.
c. they usually decrease.

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d. they do not all change proportionately.

48
. When prices change by differing degrees, consumers respond to the price changes by
a. buying less of goods whose prices have risen by relatively large amounts.
b. buying less of goods whose prices have fallen by relatively large amounts.
c. buying more of all goods.
d. buying less of all goods.
49
. When prices change by differing amounts, consumers substitute _____ the goods that have
become relatively _____ expensive.
a. toward, more
b. away from, more
c. toward, less
d. Both b and c are correct.

50
. Because the CPI is based on a fixed basket of goods, substitution bias causes the index to

48

?
~ANSWER:
a. buying less of goods whose prices have risen by relatively large amounts.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

49

?
~ANSWER:
d. Both b and c are correct.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

50

?
~ANSWER:
a. overstate the increase in the cost of living from one year to the next.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

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a. overstate the increase in the cost of living from one year to the next.
b. ignore any increase in the cost of living from one year to the next.
c. understate the increase in the cost of living from one year to the next.
d. sometimes understate, and sometimes overstate the increase in the cost of living from
one year to the next.
51
. By not taking into account the possibility of consumer substitution, the CPI _____ the
increase in the cost of living from one period to the next.
a. understates
b. overstates
c. sometimes understates and sometimes overstates
d. None of the above answers are correct.
52
. When new products are introduced, consumers have more variety from which to choose.
This greater choice makes each dollar
a. worth more.
b. worth less.
c. harder to obtain.
d. Both b and c are correct.
53
. Because the CPI is based on a fixed basket of goods, the introduction of new goods and
services in the economy causes the CPI to overestimate the cost of living. This is so
because
a. new goods and services are always of higher quality than existing goods and services.
b. new goods and services cost less than existing goods and services.
c. new goods and services cost more than existing goods and services.
d. when a new good is introduced, it gives consumers greater choice, thus reducing the
amount they must spend to maintain their standard of living.
54
. Unmeasured quality change is a problem in the CPI because
a. if the quality of a good deteriorates, the purchasing power of a dollar decreases even if
the price of the good remains the same.
b. the Bureau of Labor statistics does not attempt to account for quality changes that
affect the standard of living.
c. if the quality of a good improves, the purchasing power of a dollar increases even if the
price of the good remains the same.
d. a and c

55
. Which of the following is the most accurate statement about the effects of quality change
on the CPI?

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a. Even though the BLS adjusts prices of products in the CPI basket when the quality of
the products change, changes in quality are still a problem, because quality is so hard to
measure.
b. Because the BLS adjusts prices of products in the CPI basket when the quality of the
products change, changes in quality are no longer a problem for the CPI.
c. Because the BLS does not adjust the CPI to reflect quality changes, these changes are
not taken into account.
d. Most economists believe that changes in the quality of goods included in the CPI
basket do not bias the CPI as a measure of the cost of living.
56
. Which of the problems in the construction of the CPI is best represented by the invention of
pocket-sized computers?
a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. all of the above
e. none of the above
57
. Arturo buys a hand calculator in 1970 for $200. By 2000, the same calculator sells for $1,
and Arturo buys several. What problem in the construction of the CPI does this situation
best illustrate?
a. introduction of new goods
b. substitution bias
c. unmeasured quality change
d. all of the above
e. none of the above
58
. Laura buys word processing software in 2001 for $50. Laura’s twin brother Laurence buys
an upgrade of the same software in 2002 for $50. What problem in the construction of the
CPI does this situation best represent?
a. substitution bias
b. unmeasured quality change
c. introduction of new goods
d. all of the above
e. none of the above

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59
. Samantha goes to the grocery store to buy her year's supply of Sprite. As she enters the soft
drink section, she notices that the price of 7-Up has been reduced by 25 percent. She buys
7-Up instead of Sprite. Which problem in the construction of the CPI does this situation
best represent?
a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. all of the above
e. none of the above
60
. In 2003, OPEC succeeds in raising world oil prices by 300 percent. This price increase
causes inventors to look at alternative sources of fuel for internal-combustion engines. A
hydrogen-powered engine is developed which is cheaper to operate than gasoline engines.
Which problem in the construction of the CPI does this situation represent?
a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. a and b
e. a and c
61
. In 1970, Lyle buys a new stereo system at the Tech HiFi store. He is told by the salesman
that Professor Bose has invented a new stereo speaker which produces concert hall sound in
your living room. Lyle buys a set of Bose 501 speakers. This purchase illustrates which of
the problems in the construction of the CPI?
a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. a and b
e. b and c
62
. Consumers begin purchasing houses incorporating steel studs instead of wooden studs after
the price of lumber increases. This situation best represents which problem in the
construction of the CPI?
a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. all of the above
e. none of the above

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63
. When the price of pork rises, consumers buy more chicken. Which of the problems in the
construction of the CPI does this situation illustrate?
a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. a and b
e. a and c
64
. Solar-powered lawnmowers are invented as an alternative to existing kinds of lawnmowers.
What problem in the construction of the CPI does this situation best illustrate?
a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. a and b
e. b and c
65
. Which of the following statements best represents economists' beliefs about the bias in the
CPI as a measure of the cost of living?
a. Economists agree that the bias in the CPI is a very serious problem.
b. Economists agree that the bias in the CPI is not a serious problem.
c. Economists agree on the severity of the CPI bias, but there is still debate on what to do
about it.
d. There is still debate among economists on the severity of the CPI bias and what to do
about it.
66
. Most studies conclude that the consumer price index
a. overstates inflation by about 1 percentage point per year.
b. understates inflation by about 1 percentage point per year.
c. overstates inflation by about 3 percentage points per year.
d. understates inflation by about 3 percentage points per year.
67
. Recent changes in the CPI have
a. increased the upward bias in the CPI.
b. reduced the upward bias in the CPI.
c. increased the downward bias in the CPI.
d. reduced the downward bias in the CPI.
68
. The Bureau of Labor Statistics has evidence that the CPI

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a. understates the true rate of inflation for the elderly.

b. overstates the true rate of inflation for the elderly.
c. correctly measures the true rate of inflation for the elderly.
d. understates the true rate of inflation for all Americans.
69
. The measurement problems in the consumer price index as an indicator of the cost of living
are important because
a. many economists have their reputations hanging on the accuracy of the index.
b. many government programs use the CPI to adjust for changes in the overall level of
prices.
c. high rates of inflation cause voters to become unhappy.
d. many economists would find employment if it became necessary to make adjustments
because of the bias.
70
. If Social Security benefits increased every year by the measured inflation rate minus 1
percentage point, government spending would be
a. increased by billions of dollars each year.
b. increased by trillions of dollars each year.
c. reduced by billions of dollars each year.
d. reduced by trillions of dollars each year.
71
. The GDP deflator reflects
a. the level of prices in the base year relative to the current level of prices.
b. the level of real output in the base year relative to the current level of real output.
c. the current level of real output relative to the level of real output in the base year.
d. the current level of prices relative to the level of prices in the base year.
72
. An important difference between the GDP deflator and the consumer price index is that
a. the GDP deflator reflects the prices of goods and services bought by producers,
whereas the consumer price index reflects the prices of goods and services bought by
consumers.
b. the GDP deflator reflects the prices of all goods and services produced domestically,
whereas the consumer price index reflects the prices of goods and services bought by
consumers.
c. the GDP deflator reflects the prices of all goods and services produced by a nation's
resources, whereas the consumer price index reflects the prices of goods and services
bought by consumers.
d. the GDP deflator reflects the prices of goods and services bought by producers and
consumers, whereas the consumer price index reflects the prices of goods and services
bought by consumers.

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73
. If the prices of Canadian-made snowmobiles imported into the United States increase,
a. both the GDP deflator and the consumer price index will increase.
b. neither the GDP deflator nor the consumer price index will increase.
c. the GDP deflator will increase but the consumer price index will not increase.
d. the consumer price index will increase, but the GDP deflator will not increase.
74
. An increase in the price of domestically produced industrial robots will be reflected in
a. both the GDP deflator and the consumer price index.
b. neither the GDP deflator nor the consumer price index.
c. the GDP deflator but not in the consumer price index.
d. the consumer price index but not in the GDP deflator.
75
. A reduction in the price of large tractors imported into the United States from Russia will
cause the GDP deflator to _____ and the consumer price index to _____.
a. decrease, decrease
b. decrease, remain unchanged
c. remain unchanged, decrease
d. remain unchanged, remain unchanged
76
. An increase in the price of soft drinks produced domestically will be reflected in
a. both the GDP deflator and the consumer price index.
b. neither the GDP deflator nor the consumer price index.
c. the GDP deflator but not in the consumer price index.
d. the consumer price index but not in the GDP deflator.
77
. In the United States, if the price of imported oil rises,
a. the GDP deflator rises much more than does the consumer price index.
b. the consumer price index rises much more than does the GDP deflator.
c. the GDP deflator and the consumer price index rise by about the same amount.
d. the consumer price index rises slightly more than does the GDP deflator.

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78
. Most, but not all, baseballs used in the United States are imported from other nations. If the
price of baseballs increases,
a. the GDP deflator will increase less than will the consumer price index.
b. the GDP deflator will increase more than will the consumer price index.
c. the GDP deflator will not increase, but the consumer price index will increase.
d. the GDP deflator will increase, but the consumer price index will not increase.
79
. Suppose that U.S. mining companies purchase German-made ore trucks at a reduced price.
What will be the effect on the GDP deflator and the consumer price index?
a. The consumer price index will fall, and the GDP deflator will fall.
b. The consumer price index and the GDP deflator will be unaffected.
c. The consumer price index will fall, and the GDP deflator will be unaffected.
d. The consumer price index will be unaffected, and the GDP deflator will fall.

80
. If the price of U.S.-made computers increases,
a. the consumer price index and the GDP deflator will both increase.

78

?
~ANSWER:
a. the GDP deflator will increase less than will the consumer price index.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

79

?
~ANSWER:
b. The consumer price index and the GDP deflator will be unaffected.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

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b. the consumer price index will increase, and the GDP deflator will be unaffected.
c. the consumer price index will be unaffected, and the GDP deflator will increase.
d. the consumer price index and the GDP deflator will both be unaffected.
81
. The price of imported suitcases produced by a U.S. company operating in Thailand
increases. What effect will this change have on the GDP deflator and on the CPI?
a. The GDP deflator and the CPI will both increase.
b. The GDP deflator will increase and the CPI will be unaffected.
c. The GDP deflator and the CPI will both be unaffected.
d. The GDP deflator will be unaffected and the CPI will increase.
82
. A Brazilian company produces shirts in the United States and exports all of them to
Lithuania. If the price of the shirts increases,
a. the GDP deflator and the CPI both increase.
b. the GDP deflator is unchanged and the CPI increases.
c. the GDP deflator increases and the CPI is unchanged.
d. the GDP deflator and the CPI are unchanged.
83
. A Japanese automobile company produces cars in the United States, some of which are
exported to other nations. If the price of the cars increases,
a. the GDP deflator and the CPI will both increase.
b. the GDP deflator will increase and the CPI will be unchanged.
c. the GDP deflator will be unchanged and the CPI will increase.
d. the GDP deflator and the CPI will both be unchanged.
84
. The price of CD players increases dramatically, causing a 1 percent increase in the CPI. The
price increase will most likely cause the GDP deflator to increase by
a. more than 1 percent.
b. less than 1 percent.
c. 1 percent.
d. It is impossible to make an informed guess without more information.
85
. The price of grains used primarily for animal consumption increases. This increase is most
likely to cause
a. the U.S. consumer price index to increase by more than the GDP deflator.
b. the U.S. consumer price index to increase by less than the GDP deflator.
c. the U.S. consumer price index and GDP deflator to increase by the same percentage.
d. no change in either the consumer price index or the GDP deflator.
86
. In general, if a consumer good is produced domestically and consumed domestically, a
reduction in its price will have which of the following effects?

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 Chapter 23/Measuring the Cost of Living 21

a. the consumer price index will decrease relatively more than will the GDP deflator.
b. the consumer price index and the GDP deflator will decrease by the same amount.
c. the consumer price index will decrease relatively less than will the GDP deflator.
d. one cannot generalize about the relative decrease in the two price indices.
87
. If increases in the prices of U.S. automobiles cause the CPI to increase by 2 percent,
a. the GDP deflator will likely increase by more than 2 percent.
b. the GDP deflator will likely increase by 2 percent.
c. the GDP deflator will likely increase by less than 2 percent.
d. All of the above are equally likely.
88
. Which is the most accurate statement about the GDP deflator and the consumer price
index?
a. Both the GDP deflator and the consumer price index compare the price of a fixed
basket of goods and services to the price of the basket in the base year.
b. Both the GDP deflator and the consumer price index compare the price of currently
produced goods and services to the price of the same goods and services in the base
year.
c. The GDP deflator compares the price of a fixed basket of goods and services to the
price of the basket in the base year, but the consumer price index compares the price of
currently produced goods and services to the price of the same goods and services in
the base year.
d. The consumer price index compares the price of a fixed basket of goods and services to
the price of the basket in the base year, but the GDP deflator compares the price of
currently produced goods and services to the price of the same goods and services in
the base year.
89
. The basket of goods in the consumer price index changes _____, and the basket of goods in
the GDP deflator changes _____.
a. yearly, yearly
b. occasionally, yearly
c. yearly, occasionally
d. occasionally, occasionally

90
. Which of the following is the most accurate statement?

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22 Chapter 23/Measuring the Cost of Living

a. In the late 1970s, the late 1980s and early 1990s, the GDP deflator showed high rates
of inflation, but the consumer price index showed low rates of inflation.
b. In the late 1970s, both the GDP deflator and the consumer price index showed high
rates of inflation, and in the late 1980s and early 1990s, both measures showed low
inflation.
c. In the late 1970s, both the GDP deflator and the consumer price index showed low
rates of inflation, and in the late 1980s and early 1990s, both measures showed high
rates of inflation.
d. In the late 1970s, the late 1980s and early 1990s, both the GDP deflator and the
consumer price index showed high rates of inflation.
91
. What is the purpose of measuring the overall level of prices in the economy?
a. to allow the measurement of GDP
b. to allow comparison between dollar figures from different points in time
c. to allow government officials to determine whether the value of the dollar has
increased or decreased
d. to allow consumers to know what kinds of prices to expect in the future
92
. The CPI and the GDP deflator
a. generally move together.
b. generally show different patterns of movement.
c. always show identical changes.
d. always show different patterns of movement.
93
. Babe Ruth's 1931 salary was $80,000. The price index for 1931 is 15.2 and the price index
for 1999 is 166. Ruth's 1931 salary was equivalent to a 1999 salary of
a. about $87,000.
b. about $870,000.
c. about $1,870,000.
d. about $8,700,000.
94
. In 1931, President Herbert Hoover was paid a salary of $75,000. The price index for 1931
is 15.2, and the price index for 1999 is 166.
a. President Hoover's salary equivalent in 1999 dollars is much smaller than that of the
current U.S. president.
b. President Hoover's salary equivalent in 1999 dollars is about the same as that of the
current U.S. president.
c. President Hoover's salary equivalent in 1999 dollars is much larger than that of the
current U.S. president.
d. One cannot make a meaningful comparison of 1999 salaries and 1931 salaries.
The next three questions are based on the following information:

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 Chapter 23/Measuring the Cost of Living 23

Wally Plowman earns $3,000 from his farm operation in 1945. In 2005, Wally’s grandson Vern
earns $30,000 from the same farm. The price index for 1945 is 10, and the price index for 2005
is 150.
95
. What is Wally’s income in 2005 dollars?
a. $3,000
b. $30,000
c. $45,000
d. $130,000
96
. What is Vern’s income in 1945 dollars?
a. $2,000
b. $3,000
c. $4,500
d. $30,000
97
. What was the ratio of Vern’s real income to Wally’s real income?
a. 10:1
b. 15:1
c. 1:1
d. 2:3

The next four questions are based on the following information:

Ingrid takes a university teaching job as an assistant professor in 1972 at a salary of $10,000. By
2002, she has been promoted to full professor, with a salary of $50,000. The price index in 1972
is 50, and the price index in 2002 is 125.
98
. What is Ingrid’s 1972 salary in 2002 dollars?
a. $125,000
b. $50,000
c. $25,000
d. $10,000

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24 Chapter 23/Measuring the Cost of Living

99
. What is Ingrid’s 2002 salary in 1972 dollars?
a. $20,000
b. $150,000
c. $10,000
d. $125,000
100
. Between 1972 and 2002, the purchasing power of Ingrid’s salary has
a. increased.
b. decreased..
c. remained unchanged
d. it is impossible to tell from the information given
101
. What is the ratio of the 2002 purchasing power of Ingrid’s salary to the 1972 purchasing
power of Ingrid’s salary?
a. 2:1
b. 2.5:1
c. 5:1

99

?
~ANSWER:
a. $20,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

100

?
~ANSWER:
a. increased
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

101

?
~ANSWER:
a. 2:1
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

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 Chapter 23/Measuring the Cost of Living 25

d. 1:2
e. none of the above
102
. Craig is offered an $80,000 per year job in Los Angeles, and a $60,000 per year job in
Bismark. The CPI for Los Angeles is 120 and the CPI for Bismark is 90. What is the Los
Angeles job's purchasing power in "Bismark dollars"?
a. $80,000
b. $107,000
c. $60,000
d. $72,000

The next four questions are based on the following information:

Marie is offered a job in Boston at a salary of $60,000 per year. She is also offered a job in
Austin at a salary of $50,000 per year. The CPI for Boston is 120, and the CPI for Austin is 80.
103
. If all Marie cares about is the purchasing power of her income, which job should she take?
a. the Austin job
b. the Boston job
c. either job
d. It is impossible to make a comparison of purchasing power with the information given.

104
. What is the purchasing power of the Boston salary in Austin dollars?
a. $40,000
b. $84,000
c. $50,000
d. $72,000
105
. What is the purchasing power of the Austin salary in Boston dollars?
a. $40,000
b. $50,000
c. $60,000
d. $75,000
106
. What is the ratio of the purchasing power of the Boston salary to the purchasing power of
the Austin salary?
a. 1:1
b. 4:5

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26 Chapter 23/Measuring the Cost of Living

c. 5:4
d. 5:6
e. none of the above

The next four questions are based on the following information:

Dawna has the option of staying in her current job in Denver at an annual income of $20,000, or
transferring to Washington, D.C. at an annual income of $30,000. The cost of living index in
Denver is 90 and the cost of living index in Washington is 135.
107
. In which job will the purchasing power of Dawna's income be higher?
a. Denver
b. Washington
c. either—they both have the same purchasing power
d. it is impossible to determine with the information given
108
. What is the purchasing power of the Denver income in Washington, D.C. dollars?
a. $30,000
b. $27,000
c. $20,000
d. $15,000
e. none of the above

109
. What is the purchasing power of the Washington income in Denver dollars?
a. $40,000
b. $30,000
c. $27,000
d. $20,000
e. none of the above
110
. What is the ratio of the purchasing power of the Washington, D.C. income to the
purchasing power of the Denver income?
a. 2:1
b. 3:2
c. 1:1
d. 10:9
e. none of the above

The next four questions are based on the following information:

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 Chapter 23/Measuring the Cost of Living 27

Bill graduates from a Midwestern university and must decide between two job offers. One job
allows him to live in Lincoln, Nebraska at an annual salary of $30,000. The other job requires
Bill to move to Miami, Florida, but the salary is $45,000 per year. The CPI for Lincoln is 90, and
the CPI for Miami is 120.
111
. In which job will Bill’s income have the highest purchasing power?
a. Lincoln
b. Miami
c. either—both incomes have the same purchasing power
d. It is impossible to determine which income has the highest purchasing power.
112
. What is the purchasing power of the Lincoln job in Miami dollars?
a. $45,000
b. $40,000
c. $30,000
d. $27,000
e. none of the above

113
. What is the purchasing power of the Miami job in Lincoln dollars?
a. $54,000
b. $50,000
c. $33,750
d. $30,000
e. none of the above
114
. What is the ratio of the purchasing power of the Miami salary to the purchasing power of
the Lincoln salary?
a. 9:8
b. 4:3
c. 3:2
d. 1:1
e. none of the above
115
. When box office receipts are corrected for inflation, the No. 1 movie of all time is
a. Titanic
b. Star Wars
c. ET
d. Gone With the Wind

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28 Chapter 23/Measuring the Cost of Living

e. The Sound of Music

116
. When some dollar amount is automatically corrected for inflation by law or contract, the
amount is said to be
a. indexed for inflation.
b. deflated.
c. corrected for inflation.
d. inflated.
117
. Many long-term wage contracts between firms and unions are partially or completely
indexed with a provision called
a. a cost-of-living allowance.
b. a COLA.
c. an index allowance.
d. a, b and c
e. a and b

116

?
~ANSWER:
a. indexed for inflation.
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: Y

117

?
~ANSWER:
e. a and b
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: Y

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 Chapter 23/Measuring the Cost of Living 29

118
. A COLA automatically raises the wage rate when
a. GDP increases.
b. the labor force increases.
c. the consumer price index increases.
d. taxes increase.
119
. Which of the following are indexed for inflation?
a. the brackets of the federal income tax
b. Social Security benefits
c. state sales tax rates
d. a and b above
e. all of the above
120
. Interest represents
a. a payment now for money to be transferred in the future.
b. a payment in the future for a transfer of money in the past.
c. a payment in the past for money transferred now.

118

?
~ANSWER:
c. the consumer price index increases.
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: Y

119

?
~ANSWER:
d. a and b above
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: Y

120

?
~ANSWER:
b. a payment in the future for a transfer of money in the past.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

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30 Chapter 23/Measuring the Cost of Living

d. all of the above

121
. Which is the most accurate statement about the relationship between inflation and interest
rates?
a. There is no relationship between inflation and interest rates.
b. The interest rate is determined by the rate of inflation.
c. In order to fully understand inflation, we need to know how to correct for the effects of
interest rates.
d. In order to fully understand interest rates, we need to know how to correct for the
effects of inflation.
122
. Colleen deposits $20,000 into a saving account at the first of the year. The saving account
pays 5% interest. There is inflation during the year. Which of the following is a correct
statement about Jane's savings at the end of the year?
a. Colleen will earn $1,000 interest by the end of the year.
b. When Colleen withdraws her interest and principal, she will have $21,000.
c. Colleen will be richer by $1,000 in real terms.
d. All of the above are correct statements.
e. a and b

123
. The nominal interest rate is
a. the interest rate paid or charged by a bank.
b. the interest rate as usually reported without a correction for the effects of inflation.
c. a low interest rate.
d. all of the above
e. a and b above
124
. The real interest rate is
a. the interest rate paid or charged by a bank.
b. the interest rate corrected for the rate of inflation.
c. a high interest rate.
d. all of the above.

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 Chapter 23/Measuring the Cost of Living 31

125
. Which of the following is the most accurate statement about the relationship between the
nominal interest rate and the real interest rate?
a. The real interest rate is the nominal interest rate times the rate of inflation.
b. The real interest rate is the nominal interest rate minus the rate of inflation.
c. The real interest rate is the nominal interest rate plus the rate of inflation.
d. The real interest rate is the nominal interest rate divided by the rate of inflation.
e. None of the above are accurate statements.
126
. If the nominal interest rate is 8% and rate of inflation is 3%, the real interest rate is
a. 11%.
b. 24%.
c. 5%.
d. 3.75%.
127
. If the nominal interest rate is 5% and the rate of inflation is 10%, the real interest rate is
a. 5%.
b. 50%.
c. 15%
d. –5%.
128
. The nominal interest rate tells you
a. how fast the number of dollars in your bank account rises over time.
b. how fast the purchasing power of your bank account rises over time.
c. the number of dollars in your bank account.
d. the purchasing power in your bank account.

129
. The real interest rate tells you
a. how fast the number of dollars in your bank account rises over time.

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32 Chapter 23/Measuring the Cost of Living

b. how fast the purchasing power of your bank account rises over time.
c. the number of dollars in your bank account.
d. the purchasing power of your bank account.
130
. Which of the following is the most accurate statement about nominal and real interest rates?
a. Nominal and real interest rates always move together.
b. Nominal and real interest rates never move together.
c. Nominal and real interest rates often do not move together.
d. Nominal and real interest rates are identical.

The next four questions are based on the following information:

At the beginning of the year, Arlene deposits $1000 in a saving account that pays an annual
interest rate of 5%. Inflation for the year is 10%.
131
. At the end of the year, Arlene’s $1,000 deposit has earned
a. $1050.
b. $50.
c. $100.
d. –$50.
132
. At the end of the year, the purchasing power of Arlene’s $1000 deposit has changed by
a. $1050.
b. $50.
c. $100.

130

?
~ANSWER:
c. Nominal and real interest rates often do not move together.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

131

?
~ANSWER:
b. $50.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: N

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 Chapter 23/Measuring the Cost of Living 33

d. $–50.
133
. Which is the most correct statement about the relationship between the change in the
number of dollars in Arlene’s saving account and the change in the purchasing power of
Arlene’s saving account?
a. The purchasing power of Arlene’s account has increased more than the number of
dollars in the account.
b. The number of dollars in Arlene’s account has increased more than the purchasing
power of the account.
c. The purchasing power of Arlene's account and the number of dollars in the account
have changed by the same amount.
d. None of the above are correct statements.

134
. Which of the following is the most accurate statement about real and nominal interest rates?
a. Real interest rates can be either positive or negative, but nominal interest rates must be
positive.
b. Real interest rates and nominal interest rates must be positive.
c. Real interest rates must be positive, but nominal interest rates can be either positive or
negative.
d. Real interest rates and nominal interest rates can be either positive or negative.

The next four questions are based on the following information:

Dick N. buys a house in 1973, and finances it with a mortgage that carries an annual interest rate
of 7 percent. Inflation in 1973 is 3 percent, inflation in 1974 is 7 percent, and inflation in 1975 is
14 percent.
135
. What is the real interest rate Dick pays on his mortgage in 1973?
a. 4 percent
b. –3 percent
c. 7 percent
d. 10 percent
136
. What is the real interest rate Dick pays on his mortgage in 1974?
a. 0 percent
b. –7 percent
c. 7 percent
d. 14 percent

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34 Chapter 23/Measuring the Cost of Living

137
. What is the real interest rate Dick pays on his mortgage in 1975?
a. –14 percent
b. 7 percent
c. –7 percent
d. 21 percent
138
. What happens to the real interest rate that Dick pays between 1973 and 1975?
a. it increases.
b. it decreases
c. it remains unchanged

137

?
~ANSWER:
c. -7 percent
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: N

138

?
~ANSWER:
b. it decreases
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: N

4
ANSWER:
b. monitor changes in the cost of living.
TYPE: M SECTION: INT OBJECTIVE: RANDOM: Y

?
~ANSWER:
d. we cannot determine whether baseball stars today enjoy a higher standard of living than
Babe Ruth did in 1931 without additional information regarding increases in prices since 1931.
TYPE: M SECTION: INT OBJECTIVE: RANDOM: Y

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 Chapter 23/Measuring the Cost of Living 35

d. it decreases, then increases

139
. In the late 1970s, nominal interest rates were high and inflation rates were very high. As a
result, real interest rates were
a. very high.
b. low, and in some years they were negative.
c. moderately high.

?
~ANSWER:
c. the consumer price index.
TYPE: M SECTION: INT OBJECTIVE: RANDOM: Y

?
~ANSWER:
a. has to spend more dollars to maintain the same standard of living..
TYPE: M SECTION: INT OBJECTIVE: RANDOM: Y

?
~ANSWER:
d. the overall level of prices in the economy is increasing.
TYPE: M SECTION: INT OBJECTIVE: RANDOM: Y

?
~ANSWER:
b. inflation.
TYPE: M SECTION: INT OBJECTIVE: RANDOM: Y

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36 Chapter 23/Measuring the Cost of Living

d. impossible to determine.
140
. In the late 1990s, nominal interest rates were low and inflation was very low. As a result,
a. real interest rates were very low.
b. real interest rates were relatively low.
c. real interest rates were relatively high.
d. real interest rates were impossible to determine.

?
~ANSWER:
c. the percentage change in the price level from the previous period.
TYPE: M SECTION: INT OBJECTIVE: RANDOM: Y

?
~ANSWER:
d. Answers a and b are both correct.
TYPE: M SECTION: INT OBJECTIVE: RANDOM: Y

?
~ANSWER:
a. the overall cost of goods and services bought by a typical consumer.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

10

?
~ANSWER:
c. the Bureau of Labor Statistics
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

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 Chapter 23/Measuring the Cost of Living 37

11

?
~ANSWER:
b. monthly.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

12

?
~ANSWER:
c. the goods and services typically bought by consumers, according to Bureau of Labor
Statistics surveys.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

13

?
~ANSWER:
c. all goods and services that typical consumers buy.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

14

?
~ANSWER:

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38 Chapter 23/Measuring the Cost of Living

d. how much consumers buy of each item.

TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

15

?
~ANSWER:
b. A survey is conducted to determine how much of each good and service typical
consumers purchase.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

16

?
~ANSWER:
a. fix the basket, find the prices, compute the basket’s cost, choose a base year and compute
the index, compute the inflation rate.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

17

?
~ANSWER:
a. the benchmark against which other years are compared.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

18

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 Chapter 23/Measuring the Cost of Living 39

TRUE/FALSE

?
~ANSWER:
d. the price of the basket of goods and services in the given year divided by the price of the
basket in the base year, then multiplied by 100.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

19

?
~ANSWER:
c. housing
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

20

?
~ANSWER:
b. housing, transportation, food and beverages, and medical care.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

21

?
~ANSWER:
b. 16 percent
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

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40 Chapter 23/Measuring the Cost of Living

141
. Babe Ruth earned $80,000 in 1931, while the best players today can earn 100 times as
much. Therefore, we can conclude that modern baseball players enjoy a standard of living
about 100 times as high as Babe Ruth enjoyed in 1931.
ANSWER: F
TYPE: T SECTION: INTRO OBJECTIVE: 1 RANDOM: Y
142
. The consumer price index is used to monitor changes in the cost of living over time.
ANSWER: T
TYPE: T SECTION: INTRO OBJECTIVE: 1 RANDOM: Y

33

?
~ANSWER:
a. 20 percent between the first and second year, 33 percent between the second and third
year
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

34

?
~ANSWER:
d. All changes show the same rate of inflation.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

35

?
~ANSWER:
b. 100 to 125
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

36

?
~ANSWER:

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 Chapter 23/Measuring the Cost of Living 41

143
. The term "inflation" is used by economists to describe a situation in which the economy’s
output of goods and services is expanding.
ANSWER: F
TYPE: T SECTION: INTRO OBJECTIVE: 1 RANDOM: Y
144
. The consumer price index is a measure of the overall cost of the goods and services bought
by a typical consumer.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

a. 150 to 120
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

38

?
~ANSWER:
b. thousands
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

39

?
~ANSWER:
b. the cost of a basket of goods and services bought by firms.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

40

?
~ANSWER:
d. changes in the consumer price index.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

41

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42 Chapter 23/Measuring the Cost of Living

145
. The consumer price index is computed and reported by the Bureau of Labor Statistics each
week.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y
146
. When the Bureau of Labor Statistics calculates the consumer price index and the rate of
inflation, it uses data on the prices of about 100 goods and services.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

~ANSWER:
d. the consumer price index will increase in the future.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

42

?
~ANSWER:
b. to measure changes in the cost of living.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

43

?
~ANSWER:
a. The CPI is not a perfect measure of the cost of living.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

44

?
~ANSWER:

d. is not a perfect measure of the cost of living.

45

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 43

147
. The steps the BLS follows in constructing the CPI are (1) fix the basket, (2) find the prices,
(3) compute the basket’s cost, (4) choose a base year and compute the index, and (5)
compute the inflation rate.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y
148
. The inflation rate is the percentage change in the price index from the preceding period.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

?
~ANSWER:
d. unmeasured price change
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

46

?
~ANSWER:
b. the fact that consumers substitute toward goods that have become relatively less
expensive.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

47

?
~ANSWER:
d. they do not all change proportionately.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

37

?
~ANSWER:
b. 100 to 120
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

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44 Chapter 23/Measuring the Cost of Living

149
.
If the price index is 110 in 2000 and 115 in 2001, the rate of inflation between 2000 and
2001 is 5 percent.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y
150
. The largest category of consumer spending in the United States is housing, and the next
largest category is recreation.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

73

?
~ANSWER:
d. the consumer price index will increase, but the GDP deflator will not increase.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

74

?
~ANSWER:
c. the GDP deflator but not in the consumer price index.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

75

?
~ANSWER:
d. remain unchanged, remain unchanged
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

76

?
~ANSWER:
a. both the GDP deflator and the consumer price index.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 45

151
. Housing makes up more than half of the typical consumer's budget.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y
152
. The consumer price index is considered by economists to be an imperfect measure of the
cost of living.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

77

?
~ANSWER:
b. the consumer price index rises much more than does the GDP deflator.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

56

?
~ANSWER:
b. introduction of new goods
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

57

?
~ANSWER:
b. substitution bias
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

58

?
~ANSWER:

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
46 Chapter 23/Measuring the Cost of Living

153
. The three widely acknowledged problems in constructing the consumer price index are:
substitution bias, introduction of new goods, and unmeasured price changes.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y
154
. The consumer price index fails to take into account the fact that consumers substitute less
expensive goods for those whose prices have risen.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

b. unmeasured quality change

TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

59

?
~ANSWER:
a. substitution bias
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

60

?
~ANSWER:
d. a and b
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

61

?
~ANSWER:
e. b and c
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

62

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 47

155
. Substitution bias causes the consumer price index to understate increases in the cost of
living.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y
156
. The consumer price index automatically takes into account the impact on consumer well-
being of the introduction of new goods and services.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

~ANSWER:
a. substitution bias
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

63

?
~ANSWER:
a. substitution bias
TYPE: M: SECTION: 1 OBJECTIVE: 2 RANDOM: Y

64
ANSWER:
b. introduction of new goods
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

65

?
~ANSWER:
d. There is still debate among economists on the severity of the CPI bias and what to do
about it.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

66

?
~ANSWER:

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
48 Chapter 23/Measuring the Cost of Living

157
. Unmeasured quality change causes a bias in the consumer price index as a measure of the
cost of living.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y
158
.
Most studies conclude that the consumer price index overstates inflation by about 1
percentage point per year.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

a. overstates inflation by about 1 percentage point per year.

TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

67

?
~ANSWER:
b. reduced the upward bias in the CPI.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

68

?
~ANSWER:

a. understates the true rate of inflation for the elderly.

69

?
~ANSWER:
b. many government programs use the CPI to adjust for changes in the overall level of
prices.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

70

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 49

159
. Many government programs use the consumer price index to adjust for changes in the
overall level of prices.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y
160
. The GDP deflator is the ratio of real GDP to nominal GDP.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

?
~ANSWER:
c. reduced by billions of dollars each year.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

71

?
~ANSWER:
d. the current level of prices relative to the level of prices in the base year.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

72

?
~ANSWER:
b. the GDP deflator reflects the prices of all goods and services produced domestically,
whereas the consumer price index reflects the prices of goods and services bought by
consumers.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

91

?
~ANSWER:
b. to allow comparison between dollar figures from different points in time.
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: Y

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50 Chapter 23/Measuring the Cost of Living

161
. The GDP deflator reflects the prices of all goods and services consumed in the economy.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y
162
. If the price of imported British airliners increases, the GDP deflator will increase, but the
consumer price index will be unaffected.
ANSWER: F
TYPE: T KEY1: D SECTION: 1 OBJECTIVE: 3 RANDOM: Y

92

?
~ANSWER:

a. generally move together.

93

?
~ANSWER:
b. about $870,000.
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: Y

94

?
~ANSWER:
c. President Hoover's salary equivalent in 1999 dollars is much larger than that of the
current U.S. president..
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: Y

95

?
~ANSWER:

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 51

163
. A change in the price of an imported consumer good will affect neither the CPI nor the
GDP deflator.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y
164
. An increase in the price of a domestically produced capital good will increase the GDP
deflator, but not the CPI.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

c. $45,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

96

?
~ANSWER:
a. $2,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

97

?
~ANSWER:
d. 2:3
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

98

?
~ANSWER:
c. $25,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

82

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
52 Chapter 23/Measuring the Cost of Living

165
. An increase in the price of an imported consumer good will affect the CPI but not the GDP
deflator.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y
166
. A decrease in the price of a domestically produced consumer good will decrease both the
CPI and the GDP deflator.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

~ANSWER:
c. the GDP deflator increases and the CPI is unchanged.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

83

?
~ANSWER:
a. the GDP deflator and the CPI will both increase.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

84

?
~ANSWER:
b. less than 1 percent.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

85
ANSWER:
b. the U.S. consumer price index to increase by less than the GDP deflator.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

81

?
~ANSWER:
d. the GDP deflator will be unaffected and the CPI will increase

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 53

167
. If all tennis balls produced in the United States were also purchased by U.S. consumers,
then an increase in the price of the tennis balls would increase the CPI less than the GDP
deflator.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

87

?
~ANSWER:
c. the GDP deflator will likely increase by less than 2 percent.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

88

?
~ANSWER:
d. The consumer price index compares the price of a fixed basket of goods and services to
the price of the basket in the base year, but the GDP deflator compares the price of currently
produced goods and services to the price of the same goods and services in the base year.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

89

?
~ANSWER:
b. occasionally, yearly
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

90

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54 Chapter 23/Measuring the Cost of Living

168
. The CPI uses a fixed basket of goods and services, and the GDP deflator uses a variable
basket of goods and services.
ANSWER: T
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y
169
. In the United States, the GDP deflator and the CPI seldom move together.
ANSWER: F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

~ANSWER:
b. In the late 1970s, both the GDP deflator and the consumer price index show high rates of
inflation, and in the late 1980s and early 1990s, both measures show low inflation.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

111

?
~ANSWER:
b. Miami
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

112

?
~ANSWER:
b. $40,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

113

?
~ANSWER:
c. $33,750
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

114

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 55

170
. When Boris came to the United States in 1960, he took a job in a steel mill at $10 per day.
If the price index was 30 in 1960 and 120 in 2000, Boris’ 1960 wage in 2000 dollars was
$40 per day.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

?
~ANSWER:
a. 9:8
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

115

?
~ANSWER:
d. Gone With the Wind
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: Y

125

?
~ANSWER:
b. The real interest rate is the nominal interest rate minus the rate of inflation.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

126

?
~ANSWER:
c. 5%.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

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56 Chapter 23/Measuring the Cost of Living

171
. Pat works in New Orleans at a job that pays her $25,000 per year. She has a job offer in
Anchorage for $30,000. The CPI for New Orleans is 120, and the CPI for Anchorage is
150. The purchasing power of the Anchorage job is greater than the purchasing power of
Pat’s New Orleans job.
ANSWER: F
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

127

?
~ANSWER:
d. -5%.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

128

?
~ANSWER:
a. how fast the number of dollars in your bank account rises over time.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

129

?
~ANSWER:
b. how fast the purchasing power of your bank account rises over time.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

132

?
~ANSWER:
d. $-50.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: N

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 Chapter 23/Measuring the Cost of Living 57

172
. Fred moves from a $100,000 per year job in Philadelphia to an $80,000 per year job in San
Antonio. If the CPI for Philadelphia is 120 and the CPI for San Antonio is 100, Fred has
suffered a reduction in purchasing power.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

133

?
~ANSWER:
b. The number of dollars in Arlene’s account has increased more than the purchasing power
of the account.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: N

134

?
~ANSWER:
a. Real interest rates can be either positive or negative, but nominal interest rates must be
positive.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

135

?
~ANSWER:
a. 4 percent
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: N

136

?
~ANSWER:

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58 Chapter 23/Measuring the Cost of Living

173
. When Brenda was in college in 1995, she worked half-time for $10,000 per year. In 2001,
she is working full-time for $40,000 per year. If the 1995 CPI was 100 and the 2001 CPI is
101, the purchasing power of Brenda’s hourly wage has less than doubled.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

a. 0 percent
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: N

139

?
~ANSWER:
b. low, and in some years they were negative.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

140

?
~ANSWER:
c. real interest rates were relatively high.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

141

?
~ANSWER:
F
TYPE: T SECTION: INTRO OBJECTIVE: 1 RANDOM: Y

142

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 Chapter 23/Measuring the Cost of Living 59

174
. Gordon receives Social Security payments of $500 per month in 2001. If the Social
Security payment is fully indexed, and if the CPI increases from 100 in 2001 to 110 in
2002, Gordon’s monthly payment will be $550 in 2002.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y
175
. A COLA clause in a labor contract automatically raises the wage when the consumer price
index rises.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

~ANSWER:
T
TYPE: T SECTION: INTRO OBJECTIVE: 1 RANDOM: Y

144

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

143

?
~ANSWER:
F
TYPE: T SECTION: INTRO OBJECTIVE: 1 RANDOM: Y

146

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

145

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
60 Chapter 23/Measuring the Cost of Living

176
. In the United States, the brackets of the federal income tax and Social Security payments
are indexed for inflation.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y
177
. If Harry works for a trucking company that pays a wage fully indexed for inflation, and the
price index increases from 110 to 120, his wage will increase by 10 percent.
ANSWER: F
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

147

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

148

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

25

?
~ANSWER:
a. about 3 percent.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

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 Chapter 23/Measuring the Cost of Living 61

178
. Kareem earns $20 per hour. His wage is fully indexed for inflation. When the CPI increases
from 120 to 132, Kareem's wage increases to $22 per hour.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y
179
. Wanda is a professional basketball player in the WNBA. She signs a contract for a salary of
$1 million per year, fully indexed for inflation. If the CPI increases from 110 to 120, Sue's
salary increases by $100,000 per year.
ANSWER: F
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

26

?
~ANSWER:
b. about 10 percent.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

27

?
~ANSWER:
c. inflation.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

28

?
~ANSWER:
c. determining the percentage increase in the price index from the preceding period.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

29

?
~ANSWER:
d. 5 percent.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

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62 Chapter 23/Measuring the Cost of Living

180
. Interest represents a payment in the future for a transfer of money in the past.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y
181
. The interest rate a bank pays is the nominal interest rate, and the interest rate adjusted for
inflation is the real interest rate.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

30

?
~ANSWER:
d. the economy experienced 11 percent inflation between the first and second years and 5
percent deflation between the second and third years.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

31

?
~ANSWER:
a. 5 percent.
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

32

?
~ANSWER:
b. 10 percent between the first and second year, 11 percent between the second and third
year
TYPE: M SECTION: 1 OBJECTIVE: 1 RANDOM: Y

51

?
~ANSWER:

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 Chapter 23/Measuring the Cost of Living 63

182
. If the consumer price index rises, real interest rates will be larger than nominal interest
rates.
ANSWER: F
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y
183
. If the nominal interest rate is 6 percent and the rate of inflation is 3 percent, the real interest
rate is 3 percent.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

b. overstates
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

52

?
~ANSWER:

a. worth more

53
ANSWER:
d. when a new good is introduced, it gives consumers greater choice, thus reducing the
amount they must spend to maintain their standard of living.
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

54

?
~ANSWER:
d. a and c
TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

55

?
~ANSWER:
a. Even though the BLS adjusts prices of products in the CPI basket when the quality of the
products change, changes in quality are still a problem, because quality is so hard to measure.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
64 Chapter 23/Measuring the Cost of Living

184
. Sandra puts $1,000 in a saving account that pays an annual interest rate of 10 percent. By
the end of the year, the CPI has increased from 110 to 121. The purchasing power of
Sandra’s bank account has remained unchanged.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y
185
. The real interest rate is the nominal interest rate plus the rate of inflation.
ANSWER: F
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

TYPE: M SECTION: 1 OBJECTIVE: 2 RANDOM: Y

80

?
~ANSWER:
a. the consumer price index and the GDP deflator will both increase.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

86

?
~ANSWER:
a. the consumer price index will decrease relatively more than will the GDP deflator.
TYPE: M SECTION: 1 OBJECTIVE: 3 RANDOM: Y

102

?
~ANSWER:
c. $60,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: Y

103

?
~ANSWER:

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 Chapter 23/Measuring the Cost of Living 65

186
. The real interest rate can be negative.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y
187
. Real and nominal interest rates always move together.
ANSWER: F
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

a. the Austin job

TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

104

?
~ANSWER:
a. $40,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

105

?
~ANSWER:
d. $75,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

106

?
~ANSWER:
b. 4:5
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

107

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66 Chapter 23/Measuring the Cost of Living

188
. In the late 1970s, real interest rates in the United States were sometimes negative.
ANSWER: T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

SHORT ANSWER

~ANSWER:
c. either—they both have the same purchasing power
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

108

?
~ANSWER:
a. $30,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

109

?
~ANSWER:
d. $20,000
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

110

?
~ANSWER:
c. 1:1
TYPE: M SECTION: 2 OBJECTIVE: 4 RANDOM: N

121

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 67

189
. What are the steps followed by the Bureau of Labor Statistics in constructing the consumer
price index?
ANSWER: (1) Fix the basket of goods and services to represent the purchases of a typical
consumer.
(2) Find the prices for each of the goods and services in the basket for each point in time.
(3) Use the data on prices to calculate the cost of the basket of goods and services at
different times.
(4) Designate one year as the base year and calculate the index.
TYPE: S SECTION: 1 OBJECTIVE: 1 RANDOM: Y

?
~ANSWER:
d. In order to understand interest rates, we need to know how to correct for inflation.
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

122

?
~ANSWER:
e. a and b
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

123

?
~ANSWER:
e. a and b above
TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

124

?
~ANSWER:
b. the interest rate corrected for the rate of inflation.

TYPE: M SECTION: 2 OBJECTIVE: 5 RANDOM: Y

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68 Chapter 23/Measuring the Cost of Living

190
. In a simple economy, people consume only 2 goods, food and clothing:
food clothing
2000 price $4 $10
2000 quantity 50 100
2001 price $10 $15
2001 quantity 50 100

150

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

149

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

151

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 1 RANDOM: Y

152

?
~ANSWER:
T

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 Chapter 23/Measuring the Cost of Living 69

a. What is the percentage increase in the price of food and in the price of clothing?
b. What is the percentage increase in the overall price level?
c. Do these price changes affect all consumers to the same extent? Explain.
ANSWER: a. The price of food increased by 150 percent. The price of clothing increased by 50
percent.
b. It cost consumers a total of $1,200 to purchase 50 units of food and 100 units of
clothing in 2000. In 2001, it cost consumers $2,000 to buy the same amounts as in
2000. Therefore, the overall price level increased by 67 percent ($800/$1,200)

TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

153

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

154

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

155

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

156

?
~ANSWER:

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70 Chapter 23/Measuring the Cost of Living

c.Since the price of food increased relatively more than did the price of clothing, people
who purchase a lot of food and little clothing became worse off relative to people who
purchase a lot of clothing and little food.
TYPE: S SECTION: 1 OBJECTIVE: 1 RANDOM: Y

F
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

157

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

158

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 2 RANDOM: Y

160

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

159

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 Chapter 23/Measuring the Cost of Living 71

191
. Suppose that the price of luxury yachts and the price of mid-priced automobiles both
increased by 5 percent. Which price increase would have the larger effect on the CPI?
Explain.
ANSWER: The 5 percent increase in the price of the mid-priced automobiles would have the
larger effect on the CPI since consumers typically buy many more mid-priced automobiles
than luxury yachts, hence the weight in the CPI for mid-priced automobiles is much larger
than the weight for luxury yachts.
TYPE: S SECTION: 1 OBJECTIVE: 1 RANDOM: Y

~ANSWER:

161

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

162

?
~ANSWER:
F
TYPE: T KEY1: D SECTION: 1 OBJECTIVE: 3 RANDOM: Y

164

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

163

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72 Chapter 23/Measuring the Cost of Living

192
. Which is likely to have the larger effect on the CPI, a 3 percent increase in housing costs or
a 3 percent increase in medical costs? Explain.
ANSWER: The 3 percent increase in housing costs will have a larger impact on the CPI than will
the 3 percent increase in medical costs, since housing costs represent about 40 percent of a
typical consumer's budget, while medical costs represent less than 10 percent.
TYPE: S SECTION: 1 OBJECTIVE: 1 RANDOM: Y

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

166

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

165

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

167

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

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 Chapter 23/Measuring the Cost of Living 73

193
. What are the three major problems in using the CPI as a measure of the cost of living?
ANSWER: (1) Substitution bias. The CPI ignores the fact that consumers substitute toward
goods that have become relatively less expensive.
(2) Introduction of new goods. Because the CPI uses a fixed basket of goods, it does not
take into account the increased well-being of consumers created when new goods are
introduced.
(3) Unmeasured quality change. Not all quality changes can be measured.
TYPE: S SECTION: 1 OBJECTIVE: 2 RANDOM: Y

168

?
~ANSWER:
T
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

169

?
~ANSWER:
F
TYPE: T SECTION: 1 OBJECTIVE: 3 RANDOM: Y

170

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

171

?
~ANSWER:
F
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

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74 Chapter 23/Measuring the Cost of Living

194
. In 1970, Lyle bought a hand calculator for $200. The calculator was more accurate in its
four functions of addition, subtraction, multiplication, and division than was Lyle's $35
slide rule. In 1990, Lyle could not buy a calculator that could only perform four functions.
The simplest calculator he could find cost $5, and was much superior to his 1970 calculator.
The CPI in 1970 was 100, and in 1990 it was 250.

172

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

173

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

174

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

175

?
~ANSWER:
T

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 75

a.
Based on the CPI, what was the value of the 1990 calculator in 1970 dollars?
b.
By how much had the price of the calculator fallen in real terms from 1970 to 1990?
c.
What problems in the use of the consumer price index as a measure of the cost of living
does this story illustrate?
ANSWER: a. The value of the 1990 calculator in 1970 prices was $5 x (100/250) = $2.
b. The price of the calculator had fallen by 99 percent from 1970 to 1990.

TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

176

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

177

?
~ANSWER:
F
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

179

?
~ANSWER:
F
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

178

?
~ANSWER:

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76 Chapter 23/Measuring the Cost of Living

c.The invention of the calculator illustrates the problem of the introduction of new goods
that improve well-being but are not included in the CPI basket of goods. The
improvement in the quality of the calculator over time might not be measured,
particularly since it was not possible by 1990 to buy a calculator as simple as the 1970
model. Also, the large initial decline in the price of calculators would not be accounted
for in the index, since the basket of goods is updated only every few years.
TYPE: S SECTION: 1 OBJECTIVE: 2 RANDOM: Y

T
TYPE: T SECTION: 2 OBJECTIVE: 4 RANDOM: Y

180

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

181

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

183

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

182

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 Chapter 23/Measuring the Cost of Living 77

195
. Which problems in the construction of the CPI are illustrated by each of the following?
Explain your answer.
a. The invention of Atari, the first video game.
b. An increase in the price of Cheerios breakfast cereal, resulting in an increase of
consumer expenditures on Wheaties.
c. Increases in the speed of computers.
d. The development and sale of electric heating in homes in response to higher prices of
heating oil and natural gas.
ANSWER: a. The invention of Atari improved the well-being of consumers by offering a new
kind of entertainment, but was not reflected in the fixed-basket CPI.

~ANSWER:
F
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

184

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

185

?
~ANSWER:
F
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

186

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

187

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78 Chapter 23/Measuring the Cost of Living

b.The fixed-basket CPI does not take into account the substitution of Wheaties for
Cheerios as the price of Cheerios increases.
c. Increases in the speed of computers represents an improvement in quality, which may
not be entirely measured in the CPI.
d. The development of a new product improves consumer well-being but is not included
in the fixed baskets of goods and services, hence, is not measured by the CPI. In
addition, the substitution of cheaper electric heating for more expensive alternatives is
not taken into account by the CPI.
TYPE: S SECTION: 1 OBJECTIVE: 2 RANDOM: Y

?
~ANSWER:
F
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

188

?
~ANSWER:
T
TYPE: T SECTION: 2 OBJECTIVE: 5 RANDOM: Y

189

?
~ANSWER:
(1) Fix the basket of goods and services to represent the purchases of a typical consumer.
(2) Find the prices for each of the goods and services in the basket for each point in time.

190

~ANSWER: a. The price of food increased by 150 percent. The price of clothing increased by 50 percent.
b. It cost consumers a total of $1200 to purchase 50 units of food and 100 units of clothing in 2000.
In 2001, it cost consumers $2000 to buy the same amounts as in 2000. Therefore, the overall
price level increased by 67 percent ($800/$1200)
c. Since the price of food increased relatively more than did the price of clothing, people who
purchase a lot of food and little clothing became worse off relative to people who purchase a
lot of clothing and little food.
TYPE: S SECTION: 1 OBJECTIVE: 1 RANDOM: Y

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
 Chapter 23/Measuring the Cost of Living 79

196
. What are the differences between the CPI and the GDP deflator?
ANSWER: The GDP deflator reflects the prices of all final goods and services produced in the
economy, while the CPI reflects the prices of goods and services purchased by typical
consumers. Also, the GDP deflator uses a variable basket of goods and services—those
produced in the current year, while the CPI uses a fixed basket of goods and services—
those purchased in the base year.
TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y

191

?
~ANSWER:
The 5 percent increase in the price of the mid-priced automobiles would have the larger effect on the CPI
since consumers typically buy many more mid-priced automobiles than luxury yachts, hence the weight
in the CPI for mid-priced automobiles is much larger than the weight for luxury yachts.
TYPE: S SECTION: 1 OBJECTIVE: 1 RANDOM: Y

192

?
~ANSWER:
The 3 percent increase in housing costs will have a larger impact on the CPI than will the 3 percent
increase in medical costs, since housing costs represent about 40 percent of a typical consumer's budget,
while medical costs represent less than 10 percent.
TYPE: S SECTION: 1 OBJECTIVE: 1 RANDOM: Y

193

?
~ANSWER:
(1) Substitution bias. The CPI ignores the fact that consumers substitute toward goods that have become
relatively less expensive.
(2) Introduction of new goods. Because the CPI uses a fixed basket of goods, it does not take into account
the increased well-being of consumers created when new goods are introduced.

194

~ANSWER: a. The value of the 1990 calculator in 1970 prices was $5 x (100/250) = $2.

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80 Chapter 23/Measuring the Cost of Living

197
. If the price of imported Canadian sweaters increases, what will be the likely effects on the
CPI and the GDP deflator?
ANSWER: The CPI will increase, because imported Canadian sweaters are part of the purchases
of a typical consumer. However, the GDP deflator will be unaffected because it reflects
only the prices of domestically produced goods and services.
TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y

b. The price of the calculator had fallen by 99 percent from 1970 to 1990.
c. The invention of the calculator illustrates the problem of the introduction of new goods which
improve well-being but are not included in the CPI basket of goods. The improvement in the
quality of the calculator over time might not be measured, particularly since it was not possible
by 1990 to buy a calculator as simple as the 1970 model. Also, the large initial decline in the
price of calculators would not be accounted for in the index, since the basket of goods is
updated only every few years.
TYPE: S SECTION: 1 OBJECTIVE: 2 RANDOM: Y

195

?
~ANSWER:
a. The invention of Atari improved the well-being of consumers by offering a new kind of
entertainment, but was not reflected in the fixed-basket CPI.
b. The fixed-basket CPI does not take into account the substitution of Wheaties for Cheerios
as the price of Cheerios increases.

196

?
~ANSWER:
The GDP deflator reflects the prices of all final goods and services produced in the economy, while the
CPI reflects the prices of goods and services purchased by typical consumers. Also, the GDP deflator uses
a variable basket of goods and services--those produced in the current year, while the CPI uses a fixed
basket of goods and
services--those purchased in the base year.

197

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 Chapter 23/Measuring the Cost of Living 81

198
.
If the price of imported Russian mining trucks increases, what will be the impact on the
CPI and on the GDP deflator?
ANSWER: Neither the CPI nor the GDP deflator will increase. The CPI includes only consumer
goods, and the mining trucks are capital goods. The GDP deflator includes only
domestically produced goods, and the mining trucks are imported.
TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y
199
. For each of the following changes, indicate whether the CPI or the GDP deflator is likely to
be affected the most.
a. The price of Chevrolet cars falls.
b. The price of U.S. coal-mining machines increases.
c. The price of Italian oil tankers increases.
d. The price of imported English wool sweaters falls.
ANSWER: a. CPI falls more than GDP deflator.
b. CPI is unaffected, but GDP deflator increases.
c. CPI and GDP deflator are both unaffected.
d. CPI falls, but GDP deflator is unaffected.
TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y
200
. Will an increase in the price of pizzas sold in restaurants cause a relatively larger increase
in the CPI or in the GDP deflator?
ANSWER: Because pizzas make up a larger fraction of consumer expenditures than they do of
GDP, the price increase will cause the CPI to increase relatively more than the GDP
deflator.
TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y

~ANSWER:
The CPI will increase, because imported Canadian sweaters are part of the purchases of a typical
consumer. However, the GDP deflator will be unaffected because it reflects only the prices of
domestically-produced goods and services.
TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y

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82 Chapter 23/Measuring the Cost of Living

201
. Why does the GDP deflator give a different rate of inflation than does the CPI?
ANSWER: The GDP deflator and the CPI differ in two important ways. The GDP deflator uses
as a basket of goods all final goods and services produced in the domestic economy, while
the CPI basket includes goods and services purchased by typical consumers. Therefore,
changes in the price of imported goods affect the CPI, but not the GDP deflator. Also,
changes in the price of domestically produced capital goods affect the GDP deflator, but not
the CPI. Changes in the price of domestically produced consumer goods are likely to affect
the CPI more than the GDP deflator because it is likely that those goods make up a larger
part of consumer budgets than of GDP.

201

?
~ANSWER:
The GDP deflator and the CPI differ in two important ways. The GDP deflator uses as a basket of goods
all final goods and services produced in the domestic economy, while the CPI basket includes goods and
services purchased by typical consumers. Therefore, changes in the price of imported goods affect the
CPI, but not the GDP deflator. Also, changes in the price of domestically-produced capital goods affect
the GDP deflator, but not the CPI. Changes in the price of domestically-produced consumer goods are
likely to affect the CPI more than the GDP deflator because it is likely that those goods make up a larger
part of consumer budgets than of GDP.
TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y

199

?
~ANSWER:
a. CPI falls more than GDP deflator.
b. CPI is unaffected, but GDP deflator increases.
c. CPI and GDP deflator are both unaffected.
d. CPI falls, but GDP deflator is unaffected.
TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y
198

?
~ANSWER:

Neither the CPI nor the GDP deflator will increase. The CPI includes only consumer goods, and the
mining trucks are capital goods. The GDP deflator includes only domestically produced goods, and the
mining trucks are imported.

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 Chapter 23/Measuring the Cost of Living 83

TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y

202
. What is meant by indexation, and what are some examples of indexation in the U.S.
economy?
ANSWER: Indexation refers to the automatic correction of dollar amounts for inflation by law or
contract. Examples in the U.S. economy include COLAS, indexation of Social Security
benefits, and indexation of federal income tax brackets.
TYPE: S SECTION: 2 OBJECTIVE: 4 RANDOM: Y
203
. People in northern states spend more on house heating than do people in southern states. If
prices of heating oil and natural gas increase, and Social Security payments are indexed by
the CPI, what happens to the relative economic well-being of Social Security recipients in
northern and southern states?
ANSWER: Since the CPI reflects the purchases of natural gas and heating oil of typical
consumers, Social Security recipients in northern states will find that their economic well-
being has decreased relative to the economic well-being of Social Security recipients in
southern states. Since the CPI overestimates the cost of living, both groups may actually be
better off after the increase in oil and gas prices. Certainly, the southern group will be better
off.
TYPE: S SECTION: 2 OBJECTIVE: 4 RANDOM: Y

200

?
~ANSWER:
Because pizzas make up a larger fraction of consumer expenditures than they do of GDP, the price
increase will cause the CPI to increase relatively more than the GDP deflator.
TYPE: S SECTION: 1 OBJECTIVE: 3 RANDOM: Y

202

?
~ANSWER:
Indexation refers to the automatic correction of dollar amounts for inflation by law or contract. Examples
in the U.S. economy include COLAS, indexation of Social Security benefits, and indexation of federal
income tax brackets.
TYPE: S SECTION: 2 OBJECTIVE: 4 RANDOM: Y

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84 Chapter 23/Measuring the Cost of Living

204
. Why do you suppose that U.S. federal income tax brackets are now indexed for inflation?
ANSWER: The federal income tax brackets are indexed because without indexation, inflation
causes people's income to be pushed into income tax brackets with higher marginal rates,
increasing their real taxes. People complained about this, and their elected representatives
changed the tax laws.
TYPE: S SECTION: 2 OBJECTIVE: 4 RANDOM: Y

204

?
~ANSWER:
The federal income tax brackets are indexed because without indexation, inflation causes people's income
to be pushed into income tax brackets with higher marginal rates, increasing their real taxes. People
complained about this, and their elected representatives changed the tax laws.
TYPE: S SECTION: 2 OBJECTIVE: 4 RANDOM: Y

203

?
~ANSWER:
Since the CPI reflects the purchases of natural gas and heating oil of typical consumers, Social Security
recipients in northern states will find that their economic well-being has decreased relative to the
economic well-being of Social Security recipients in southern states. Since the CPI overestimates the cost
of living, both groups may actually be better off after the increase in oil and gas prices. Certainly, the
southern group will be better off.
TYPE: S SECTION: 2 OBJECTIVE: 4 RANDOM: Y

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 Chapter 23/Measuring the Cost of Living 85

205
. Can the real interest rate be negative? Explain.
ANSWER: The real interest rate is the nominal interest rate minus the rate of inflation. If the rate
of inflation is greater than the nominal interest rate, the real interest rate is negative.
TYPE: S SECTION: 2 OBJECTIVE: 5 RANDOM: Y
206
. Henry and Ellen meet George, the banker, to work out the details of a loan. George, Ellen,
and Henry all expect that inflation will be 5 percent over the term of the loan, and they
agree on a nominal interest rate of 10 percent. In actuality, the inflation rate is 8 percent
over the term of the loan.
a. What was the expected real interest rate?
b. What was the actual real interest rate?
c. Who benefited and who lost because of the unexpected inflation?
ANSWER: a. The expected real interest rate was 5 percent.
b. The actual real interest rate was 2 percent.
c. George, the banker lost because he receives less real interest income than he expected.
Henry and Ellen gain because they pay less real interest income than they expected.
TYPE: S SECTION: 2 OBJECTIVE: 5 RANDOM: Y

206

?
~ANSWER:
a. The expected real interest rate was 5%.
b. The actual real interest rate was 2%.

205

?
~ANSWER:
The real interest rate is the nominal interest rate minus the rate of inflation. If the rate of inflation is
greater than the nominal interest rate, the real interest rate is negative.
TYPE: S SECTION: 2 OBJECTIVE: 5 RANDOM: Y

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86 Chapter 23/Measuring the Cost of Living

207
. Les buys a house in 1998. He obtains a fixed 10 percent mortgage interest rate, and makes
payments of $1,000 per month. The 1998 CPI is 90, the 1999 CPI is 90, the 2000 CPI is

207

~ANSWER: a. The real mortgage interest rate in 1999 is 10 percent, in 2000 is -1 percent, in 2001 is 0
percent and in 2002 is 1 percent.
b. Les's 1999 payment in 1998 dollars is $1,000, his 2000 payment in 1998 dollars is $900, his 2001
payment in 1998 dollars is $818, and his 2002 payment in 1998 dollars is $750.
TYPE: S SECTION: 2 OBJECTIVE: 5 RANDOM: Y

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 Chapter 23/Measuring the Cost of Living 87

100, the 2001 CPI is 110, and the 2002 CPI is 120.
a. What is the real mortgage interest rate Les pays in 1999, 2000, and 2001, and 2002?
b. What are the values in 1998 dollars of Les's monthly mortgage payments in 1999,
2000, 2001, and 2002?
ANSWER: a. The real mortgage interest rate in 1999 is 10 percent, in 2000 is -1 percent, in
2001 is 0 percent and in 2002 is 1 percent.
b. Les's 1999 payment in 1998 dollars is $1,000, his 2000 payment in 1998 dollars is
$900, his 2001 payment in 1998 dollars is $818, and his 2002 payment in 1998 dollars
is $750.
TYPE: S SECTION: 2 OBJECTIVE: 5 RANDOM: Y

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