Deck 4: Measuring the Cost of Living

Question 1

It is impossible for real interest rates to be negative.

Answer 1

False

Question 2

An increase in the price of helicopters purchased by the SA National Defence Force is captured by the Consumer Prices Index (CPI).

Answer 2

False

Question 3

An increase in the price of imported cameras is captured by the Consumer Prices Index (CPI) but not by the GDP deflator.

Answer 3

True

Question 4

Because an increase in petrol prices causes consumers to ride their bikes more and drive their cars less, the Consumer Prices Index (CPI) tends to underestimate the cost of living.

Question 5

The first step in computing the CPI is to determine which prices are most important to the

A)personal buyer.
B)professional shopper.
C)purchasing agent.
D)typical consumer.

Question 6

Which price index measures the average price of things purchased by the typical family?

A)GDP deflator.
B)Producer price index.
C)Consumer price index.
D)Minimum wage.

Question 7

The good that receives the most weight in the CPI is the good that

A)consumers buy most frequently.
B)has experienced the greatest price increase.
C)has the highest price.
D)consumers spend the largest fraction of their income on.

Question 8

Which item would receive the least weight in the CPI?

A)Brooms.
B)Cars.
C)Televisions.
D)Car tyres.

Question 9

The CPI is used to

A)convert nominal GDP into real GDP.
B)monitor changes in the cost of living over time.
C)characterize the types of goods and services that consumers purchase.
D)measure the quantity of goods and services that the economy produces.

Question 10

Which of the following is a reason why the CPI is not calculated as a simple average of all prices?

A)Some goods experience large price changes and the CPI would be too variable if computed by a simple average.
B)Goods differ in their importance in the average consumer's budget.
C)Some goods never experience price changes and the CPI would not be variable enough if computed as a simple average.
D)It would be difficult to compute a price index using a simple average of all prices.

Question 11

If the Consumer Prices Index (CPI) rises at 5 per cent per year, then every individual in the country needs exactly a 5 per cent increase in their income for their standard of living to remain constant.

Question 12

If your wage rises from R5000 per week to R6250 per week while the Consumer Prices Index (CPI) rises from 112 to 121, you should feel an increase in your standard of living.

Question 13

The CPI is used to

A)monitor changes in the level of wholesale prices in the economy.
B)monitor changes in the cost of living over time.
C)monitor changes in the level of real GDP over time.
D)monitor changes in the stock market.

Question 14

An increase in the price of diamonds will have a greater impact on the Consumer Prices Index (CPI) than an equal percentage increase in the price of food because diamonds are so much more expensive.

Question 15

Which item would receive the most weight in the consumer price index?

A)Salt.
B)Toothpicks.
C)Pencils.
D)Food.

Question 16

If the nominal interest rate is 12 per cent and the rate of inflation is 7 per cent, then the real rate of interest is 5 per cent.

Question 17

Inflation can be measured by all of the following except the

A)All of these answers are used to measure inflation.
B)Consumer prices index.
C)Producer prices index.
D)GDP deflator.
E)Finished goods price index.

Question 18

The "base year" in a price index is the benchmark year against which other years are compared.

Question 19

If lenders demand a real rate of return of 4 per cent and they expect inflation to be 5 per cent, then they should charge 9 per cent interest when they extend loans.

Question 20

The second step in computing the CPI is to find the prices of each of the goods and services in the ________ for each point in time.

A)household
B)basket
C)kitchen pantry
D)supermarket

Question 21

Suppose you spend 30 per cent of your budget on food, 20 per cent on transport, 40 per cent on rent, 5 per cent on entertainment, and 5 per cent on miscellaneous items.If the price of all parts of your budget rises equally in percentage terms, which would have the most weight on your cost of living increase? (Assume you calculate your index the same way the CPI is calculated.)

A)Food
B)Transport
C)Rent
D)Entertainment

Question 22

If the CPI has a value of 115 today and the base year is 2014, then consumer prices have

A)increased by 15 per cent since the base year.
B)increased by 1.5 per cent since the base year.
C)more than doubled since the base year.
D)declined 15 per cent since the base year.

Question 23

Which of the following would probably cause the CPI to rise more than the GDP deflator in SA? An increase in the price of

A)BMWs produced in Germany and sold in SA.
B)Peugeots produced in SA.
C)helicopters purchased by the South African Navy.
D)domestically produced armoured vehicles sold exclusively to India.

Question 24

The GDP deflator differs from the CPI because the GDP deflator includes goods a country __________, while the CPI includes goods the country __________.

A)imports; exports
B)exports; imports
C)buys; sells
D)consumes; produces

Question 25

Suppose your income rises from R361 000 to R589 000 while the CPI rises from 122 to 169.Your standard of living has likely

A)fallen.
B)You can't tell without knowing the base year.
C)risen.
D)stayed the same.

Question 26

The table shows the prices and the quantities consumed in Carnivore Country.The base year is 2013.This means that 2013 is the year the typical basket was determined so the quantities consumed in 2013 are the only quantities needed to calculate the CPI in each year.
Table
$$\begin{array} { | c | c | c | c | c | } \hline \text { Year } & \begin{array} { c } \text { Price of } \\\text { beef }\end{array} & \begin{array} { c } \text { Quartity of } \\\text { beef }\end{array} & \begin{array} { c } \text { Price of } \\\text { pork }\end{array} & \begin{array} { c } \text { Quartity of } \\\text { pork }\end{array} \\\hline 2013 & \text { R38 } & 100 & \text { R19 } & 100 \\\hline 2014 & \text { R47.50 } & 90 & \text { R.7.10 } & 120 \\\hline 2015 & \text { R52.25 } & 105 & \text { R19 } & 130 \\\hline\end{array}$$

-Refer to the table above.What is the value of the basket in the base year?

A)R1045
B)R5700
C)R6327
D)R7956.25
E)R8725.75

Question 27

If there is an increase in the price of apples, which causes consumers to purchase fewer kilograms of apples and more kilograms of oranges, the CPI will suffer from

A)consumer preference bias.
B)substitution bias.
C)base year bias.
D)bias due to unmeasured quality change.
E)bias due to the introduction of new goods.

Question 28

If the nominal interest rate is 7 per cent and the inflation rate is 3 per cent, then the real interest rate is

A)-4 per cent.
B)3 per cent.
C)4 per cent.
D)10 per cent.
E)21 per cent.

Question 29

If inflation is 8 per cent and the real interest rate is 3 per cent, then the nominal interest rate must be

A)3/8 per cent.
B)-5 per cent.
C)5 per cent.
D)11 per cent.
E)24 per cent.

Question 30

Which of the following statements is correct?

A)The real interest rate is the sum of the nominal interest rate and the inflation rate.
B)The nominal interest rate is the inflation rate minus the real interest rate.
C)The nominal interest rate is the real interest rate minus the inflation rate.
D)The real interest rate is the nominal interest rate minus the inflation rate.

Question 31

Substitution bias

A)is one factor that causes the CPI to underestimate the inflation rate.
B)is caused by the poor quality of many imported products.
C)is one of the primary causes of inflation.
D)involves consumer behaviour that helps explain why the CPI overestimates the inflation rate.

Question 32

Improvements in the quality of consumer goods and services over time

A)cause the CPI to overstate actual inflation.
B)cause the CPI to understate actual inflation.
C)are accounted for in the CPI.
D)are insignificant and thus would not affect the CPI even if accounted for.

Question 33

If the CPI has a value of 150 today and the base year is 2000, then it costs

A)R100 today to buy what cost R150 in the base year.
B)R1 today to buy what cost R150 in the base year.
C)R150 today to buy what cost R100 in the base year.
D)R2 today to buy what cost R1 in the base year.

Question 34

Which of the following answers would accurately describe the bias in the CPI resulting from the fact that oil prices suddenly increase?

A)The CPI would underestimate the cost of living.
B)The CPI would overestimate the cost of living.
C)The CPI would not be biased as a result of a sudden rise in oil prices.
D)The CPI could overestimate or underestimate the cost of living, depending upon the quantity of oil purchased in that year.

Question 35

The table shows the prices and the quantities consumed in Carnivore Country.The base year is 2013.This means that 2013 is the year the typical basket was determined so the quantities consumed in 2013 are the only quantities needed to calculate the CPI in each year.
Table
$$\begin{array} { | c | c | c | c | c | } \hline \text { Year } & \begin{array} { c } \text { Price of } \\\text { beef }\end{array} & \begin{array} { c } \text { Quartity of } \\\text { beef }\end{array} & \begin{array} { c } \text { Price of } \\\text { pork }\end{array} & \begin{array} { c } \text { Quartity of } \\\text { pork }\end{array} \\\hline 2013 & \text { R38 } & 100 & \text { R19 } & 100 \\\hline 2014 & \text { R47.50 } & 90 & \text { R.7.10 } & 120 \\\hline 2015 & \text { R52.25 } & 105 & \text { R19 } & 130 \\\hline\end{array}$$

-Refer to the table above.What are the values of the CPI in 2013, 2014, and 2015, respectively?

A)83.5, 94.2, 100
B)100, 113.3, 125
C)None of these answers.
D)100, 111, 139.6
E)100, 109.2, 116

Question 36

If a lender wants a real return of 6 per cent and she expects inflation to be 4 per cent, which of the following is the nominal interest rate to charge?

A)4 per cent.
B)6 per cent.
C)2 per cent.
D)10 per cent.

Question 37

The CPI differs from the GDP deflator in that the CPI includes

A)raw material prices whereas the GDP deflator does not.
B)only goods whereas the GDP deflator includes both goods and services.
C)only services whereas the GDP deflator includes both goods and services.
D)only items the typical household buys, whereas the GDP deflator includes all goods and services produced in the economy.

Question 38

If the price of the market basket of goods in a country for the base year of 2013 was R20,000 and the price of the same basket had risen to R22,000 by 2014, the CPI for 2014

A)cannot be calculated.
B)is R12,000.
C)is 200.
D)is 110.

Question 39

In 2012, the CPI was 124.0 in a country. In 2013, it was 130.7.What was the rate of inflation over this period?

A)5.4 per cent.
B)6.7 per cent.
C)30.7 per cent.
D)You can't tell without knowing the base year.

Question 40

The "basket" on which the CPI is based is composed of

A)consumer production.
B)products purchased by the typical consumer.
C)raw materials purchased by firms.
D)total current production.
E)a selection of consumer goods typically purchased over the last 30 years.

Question 41

When the inflation rate ends up being lower than expected,

A)everyone benefits because money is cheaper.
B)everyone benefits because prices do not increase.
C)lenders of fixed rate mortgages generally benefit because they will make higher profits than they had calculated.
D)borrowers with fixed rate loans will benefit because their purchasing power will not decline as much.

Question 42

Under which of the following conditions would you prefer to be the lender?

A)The nominal rate of interest is 15 per cent and the inflation rate is 14 per cent.
B)The nominal rate of interest is 20 per cent and the inflation rate is 25 per cent.
C)The nominal rate of interest is 12 per cent and the inflation rate is 9 per cent.
D)The nominal rate of interest is 5 per cent and the inflation rate is 1 per cent.

Question 43

Why will individual shoppers face different inflation rates?

Question 44

List the three major problems in using the CPI as a measure of the cost of living.

Question 45

If workers and firms agree on an increase in wages based on their expectations of inflation and inflation turns out to be more than they expected,

A)the interest rate will fall.
B)workers will gain at the expense of firms.
C)neither workers nor firms will gain because the increase in wages is fixed in the labour agreement.
D)firms will gain at the expense of workers.

Question 46

In a simple economy, people consume only 2 goods, food and clothing.The market basket of goods used to compute the CPI consists of 50 units of food and 10 units of clothing.

a.What is the percentage increases in the price of food and in the price of clothing?
b.What is the percentage increase in the CPI?
c.Do these price changes affect all consumers to the same extent? Explain.

Question 47

How does the GDP deflator differ from the CPI?

Question 48

Since the global financial crisis in 2007-09, real interest rates have been negative.This means that inflation is eroding people's savings more quickly than ________________ are increasing their savings.

A)retail payments
B)consumer interest payments
C)nominal interest payments
D)nominal interest rates

Question 49

If you borrow money at a nominal interest rate of 5 per cent and the inflation rate is 10 per cent, what real interest rate will you pay?

A)-5 per cent.
B)0.5 per cent.
C)2 per cent.
D)10 per cent.

Question 50

What does the CPI measure?

Question 51

Jay and Joyce meet George, the banker, to work out the details of a mortgage.They all expect that inflation will be 2 per cent over the term of the loan, and they agree on a nominal interest rate of 6 per cent.As it turns out, the inflation rate is 5 per cent 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?

Question 52

If borrowers and lenders agree on a nominal interest rate and inflation turns out to be less than they had expected,

A)neither borrowers nor lenders will gain because the nominal interest rate has been fixed by contract.
B)the interest rate will rise.
C)borrowers will gain at the expense of lenders.
D)lenders will gain at the expense of borrowers.

Question 53

Why does the GDP deflator give a different rate of inflation than the CPI?

Question 54

Under which of the following conditions would you prefer to be the borrower?

A)The nominal rate of interest is 12 per cent and the inflation rate is 9 per cent.
B)The nominal rate of interest is 20 per cent and the inflation rate is 25 per cent.
C)The nominal rate of interest is 5 per cent and the inflation rate is 1 per cent.
D)The nominal rate of interest is 15 per cent and the inflation rate is 14 per cent.

Question 55

Which is likely to have the larger effect on the CPI, a 2 per cent increase in the price of food or a 3 per cent increase in the price of diamond rings? Explain.

Question 56

A worker received R50 for a daily wage in 2000.What is the value of that wage today if the CPI was 20 in 2000 and is 80 today?

A)R50
B)R200
C)R300
D)R400

Question 57

When borrowing money to purchase a car, Thabo has the choice between a fixed nominal interest rate and adjustable nominal interest rate loan.Typically the adjustable rate loans start with a lower rate than the fixed rate loan.Given that, Thabo would probably want to borrow money at the higher fixed rate when he expects the

A)inflation rate to rise.
B)inflation rate to fall.
C)inflation rate to remain unchanged.
D)government to take action to lower the inflation rate in the near future.

Question 58

Compute how much each of the following items is worth in terms of today's euros using 177 as the price index for today.
a.In 1926, the CPI was 17.7 and the price of a cinema ticket was r₀.25.
b.In 1932, the CPI was 13.1 and a cook earned r₁5.00 a week.
c.In 1943, the CPI was 17.4 and a litre of petrol cost r₀.19.