Practice Questions 2

Chapter 21 Instructor: Aysel Bandad

1. When the consumer price index falls, 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 save less because they do not need to offset the effects of rising prices.

2. In the calculation of the CPI, tea is given greater weight than beer if

a. the price of tea is higher than the price of beer.

b. it costs more to produce tea than it costs to produce beer.
c. tea is more readily available than beer to the typical consumer.
d. consumers buy more tea than beer.

3. In computing the consumer price index, a base year is chosen. Which of the following
statements about the base year is correct?

a. The base year is always the first year among the years for which computations are being
made.
b. It is necessary to designate a base year only in the simplest case of two goods; in more
realistic cases, it is not necessary to designate a base year.
c. The value of the consumer price index is always 100 in the base year.
d. The base year is always the year in which the cost of the basket was highest among the
years for which computations are being made.

4. Suppose a basket of goods and services has been selected to calculate the CPI. In 2002, the
basket’s cost was $80; in 2008, the basket’s cost was $92; and in 2010, the basket’s cost was
$108. The base year must be

a. 2002.
b. 2008.
c. one of the years between 2008 and 2010.
d. The base year cannot be determined from the given information.

5. In an imaginary economy, consumers buy only razors and cologne. The fixed basket consists
of 6 razors and 4 bottles of cologne. A razor cost $20 in 2009 and $25 in 2010. A bottle of
cologne cost $30 in 2009 and $40 in 2010. Using 2009 as the base year, which of the following
statements is correct?

a. For the typical consumer, the number of dollars spent on razors is equal to the number of
dollars spent on cologne in each of the two years.
b. The consumer price index is 310 in 2010.
c. The rate of inflation is 29.17% in 2010.
d. None of the above is correct.

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 Practice Questions 2

Chapter 21 Instructor: Aysel Bandad

6. In an imaginary economy, consumers buy only hot dogs and hamburgers. The fixed basket
consists of 10 hot dogs and 6 hamburgers. A hot dog cost $3 in 2006 and $5.40 in 2007. A
hamburger cost $5 in 2006 and $6 in 2007. Which of the following statements is correct?

a. When 2006 is chosen as the base year, the consumer price index is 90 in 2007.
b. When 2006 is chosen as the base year, the inflation rate is 150 percent in 2007.
c. When 2007 is chosen as the base year, the consumer price index is 100 in 2006.
d. When 2007 is chosen as the base year, the inflation rate is 50 percent in 2007.

7. Suppose that the prices of dairy products have risen relatively less than prices in general over
the last several years. To which problem in the construction of the CPI is this situation most
relevant?

a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. income bias

8. 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.

9. The price index was 220 in one year and 260 in the next year. What was the inflation rate?
a. 9.0 percent
b. 114.6 percent
c. 18.2 percent
d. 40.0 percent

10. If the price of Spanish olives imported into the United States decreases, then
a. both the GDP deflator and the consumer price index will decrease.
b. neither the GDP deflator nor the consumer price index will decrease.
c. the GDP deflator will decrease, but the consumer price index will not decrease.
d. the consumer price index will decrease, but the GDP deflator will not decrease.

11. If the nominal interest rate is 5 percent and the rate of inflation is 9 percent, then the real
interest rate is
a. -4 percent.
b. -0.44 percent.
c. 4 percent.
d. 14 percent.

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 Practice Questions 2

Chapter 21 Instructor: Aysel Bandad

Table 1

The table below shows the prices of baseballs and baseball bats for three years. Assume the
typical consumer’s basket consists of 6 baseballs and 2 baseball bats.

Price of a Price of a
Year Baseball Baseball Bat
2008 $3.25 $75
2009 $3.75 $82
2010 $4.50 $96

12. Refer to Table 1. How much was the cost of the basket in 2008?

a. $78.25
b. $84.75
c. $169.50
d. $456.50

13. Refer to Table 1. If 2008 is the base year, then the consumer price index was

a. 100.00 in 2008, 110.03 in 2009, and 117.43 in 2010.

b. 100.00 in 2008, 110.03 in 2009, and 129.20 in 2010.
c. 100.00 in 2008, 117.00 in 2009, and 132.50 in 2010.
d. 169.50 in 2008, 186.50 in 2009, and 219.00 in 2010.

14. Refer to Table 1. The inflation rate was

a. 10.03 percent in 2009 and 17.43 percent in 2010.

b. 17.00 percent in 2009 and 32.50 percent in 2010.
c. 10.03 percent in 2009 and 29.20 percent in 2010.
d. 17.00 percent in 2009 and 29.20 percent in 2010.

15. When the quality of a good improves while its price remains the same, the purchasing power
of the dollar

a. increases, so the CPI overstates the change in the cost of living if the quality change is not
accounted for.
b. increases, so the CPI understates the change in the cost of living if the quality change is
not accounted for.
c. decreases, so the CPI overstates the change in the cost of living if the quality change is not
accounted for.
d. decreases, so the CPI understates the change in the cost of living if the quality change is
not accounted for.

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 Practice Questions 2

Chapter 21 Instructor: Aysel Bandad

16. Which of the problems in the construction of the CPI might be illustrated by each of the
following situations? Explain.

a. The increase in downloading movies

b. The introduction of air bags in cars
c. Increased personal computer purchases in response to a decline in their price
d. Increased use of digital cameras in smart phones
e. Greater use of fuel-efficient cars after petrol prices increase.

17. Suppose that you lend your flatmate €100 for one year at 9 per cent nominal interest.

a. How many euro of interest will your flatmate pay at the end of the year?
b. Suppose at the end of the year, you are surprised to discover that the actual inflation rate
over the year was 8 per cent. What was the actual real interest rate generated by this loan?
c. In the case described above, actual inflation turned out to be higher than expected. Which
of the two of you had the unexpected gain or loss? Your flatmate (the borrower), or you
(the lender)? Why?