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# In Merryland there are only 3 goods popcorn movie shows and diet drinks The following table shows the prices and quantities produced of these goods

Q.1: In Merryland, there are only 3 goods: popcorn, movie shows, and diet drinks. The following table shows the prices and quantities produced of these goods in 1980, 1990, and 1991:

 1980 1990 1991 P Q P Q P Q Popcorn 1.00 500 1.00 600 1.05 590 Movie Shows 5.00 300 10.00 200 10.50 210 Diet Drinks 0.70 300 0.80 400 0.75 420

Note: The quantities (Q) in the table above are not used in answering the questions below. These would be used, however, to calculate both GDP and the GDP deflator. (The GDP deflator is the price index associated with GDP, where the bundle of goods under consideration is the aggregate output of the economy. It is used to convert between nominal and real GDP.)

a) A "market bundle" for a typical family is deemed to be 5 popcorn, 3 movie shows, and 3 diet drinks. Compute the consumer price index (CPI) for each of the three years, using 1980 as the base year.

CPI80= {(5*1.00 )+(3*5.00 )+(3*.70 )}*100/{(5*1.00 )+(3*5.00 )+(3*.70 )}

CPI80= 100

CPI90= {(5*1.00 )+(3*10.00 )+(3*.080 )}*100/{(5*1.00 )+(3*5.00 )+(3*.70 )}

CPI90=169.2

CPI91= {(5*1.05 )+(3*10.50 )+(3*.75 )}*100/{(5*1.00 )+(3*5.00 )+(3*.70 )}

CPI91= 176.5

b) What was the rate of inflation from 1990 to 1991, using the CPI you calculated in (a)?

Answer: Rate of inflation is the percentage change in the index over the two periods. Therefore rate of inflation from 1990to 1991, is

[(176.5-169.2)*100]/169.2=4.3%

c) Now compute the CPI for each of the three years, using 1990 as the base year instead of 1980 but using the same "market bundle.

CPI80= {(5*1.00 )+(3*5.00 )+(3*.70 )}*100/{(5*1.00 )+(3*10.00 )+(3*.080 )}

CPI80= 59.1

CPI90= {(5*1.00 )+(3*10.00 )+(3*.080 )}*100/{(5*1.00 )+(3*10.00 )+(3*.80 )}

CPI90=100

CPI91= {(5*1.05 )+(3*10.50 )+(3*.75 )}*100/{(5*1.00 )+(3*10.00 )+(3*.80 )}

CPI91= 104.3

d) What was the rate of inflation from 1990 to 1991, using the CPI you calculated in (c)? Is it the same as your answer to (b)?

Yes both the rate of inflation is same. The rate of inflation only accounts for the percentage change in prices over two periods, irrespective of the base year.

e) Now suppose that a new market bundle is defined; the "market bundle" is now 6 popcorn, 2 movie shows, and 4 diet drinks. Compute the CPI for the three years, using this "market bundle" and using 1980 as the base year.

CPI80= {(6*1.00 )+(2*5.00 )+(4*.70 )}*100/{(6*1.00 )+(2*5.00 )+(4*.70 )}

CPI80= 100

CPI90= {(6*1.00 )+(2*10.00 )+(4*.080 )}*100/{(6*1.00 )+(2*5.00 )+(4*.70 )}

CPI90=155.3

CPI91= {(6*1.05 )+(2*10.50 )+(4*.75 )}*100/{(6*1.00 )+(2*5.00 )+(4*.70 )}

CPI91= 161.2

f) What was the rate of inflation from 1990 to 1991, using the CPI you calculated in (e)? Explain why it is different from your answer to (b)?