The Bank of Canada Regularly Announces the Inflation Rate

Essay

The Bank of Canada regularly announces the inflation rate. Many economic aspects, such as employment, wages, loans, interest rates, and business contracts are influenced by the announced inflation rate. Thus, the way the inflation rate is determined has important consequences on many people's lives. Let us construct a very simplified economic model to illustrate the implications of changing the composition of the CPI basket, which in turn determines how the inflation rate is calculated.
Think of an economy consisting of two people, Betty and Trent. They only consume books and food: Betty receives meals for free from a foreign admirer, and she only buys 20 books a week for the price of $4 apiece. Trent has no time to read, so that he buys 14 meals a week for the price of $10 apiece.
a) Calculate Betty and Trent's expenditures and their total expenditure.
b) Suppose the price of meals increases by 10 percent, to $11. Calculate the CPI inflation rate, and compare the increases in expenditures implied by this rate with the actual increases in expenditures for each individual.
c) Suppose the government wishes to compensate consumers for the increase in prices by an amount determined by the CPI inflation. Who benefits more by this compensation, Betty or Trent?