CHAPTER 11: MEASURING COST OF LIVING

1. Which price index measures the average price of things purchased by the
typical family in an urban area?
a. GDP deflator
b. producer price index
c. consumer price index
d. minimum wage

2. Which item would receive the most weight in the consumer price index?
a. salt
b. toothpicks
c. pencils
d. food

3. Which item would receive the least weight in the consumer price index?
a. brooms
b. automobiles
c. color televisions
d. automobile tires

4. 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.

5. Which of the following is a reason why the Consumer Price Index (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.

6. If the price of the market basket of goods in the base year of 1994 was
$20,000 and the price of the same basket had risen to $22,000 by 1998, the CPI
for 1998
a. cannot be calculated.
b. is $12,000.
c. is 200.
d. is 110.

7. Suppose you spend 30 percent of your budget on food, 20 percent on

medical care, 40 percent on rent, 5 percent on entertainment, and 5 percent
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. medical care
c. rent
d. entertainment

8. 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 behavior that helps explain why the CPI overestimates the
inflation rate.

9. 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.

10. Factors that cause the CPI to exaggerate the inflation rate do not include
a. the tendency of consumers to substitute relatively cheaper goods for those that
have become relatively more expensive.
b. political pressure from unions and retirees on the Bureau of Labor Statistics to
overstate the inflation rate.
c. the introduction of new technologies that make it easier to obtain the same
standard of living.
d. improvements over time on the quality of products.

11. Which of the following answers would accurately describe the bias in the
CPI resulting from the fact that oil prices suddenly increase?
a. underestimate the cost of living
b. overestimate the cost of living
c. have no bias effect on the CPI
d. could overestimate or underestimate the cost of living, depending upon the
quantity of oil purchased in that year

12. 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.

13. The CPI differs from the GDP deflator in that the CPI
a. uses base-year quantities of goods to weight prices.
b. uses current-year quantities of goods to weight prices.
c. is not a weighted price index.
d. always indicates a higher rate of inflation than the GDP deflator.

14. The GDP deflator differs from the CPI because the GDP deflator includes
goods we __________, while the CPI includes goods we __________.
a. import; export
b. export; import
c. buy; sell
d. consume; produce

15. If the consumer price index has a value of 150 today and the base year is
1987, then consumer prices have
a. increased by 50 percent since 1987.
b. doubled since 1987.
c. more than doubled since 1987.
d. declined 50 percent since 1987.

16. If the consumer price index has a value of 150 today and the base year is
1987, then it costs
a. $100 today to buy what cost $150 in the base year.
b. $1 today to buy what cost $150 in the base year.
c. $150 today to buy what cost $100 in the base year.
d. $2 today to buy what cost $1 in the base year.

17. Use this table to find the real wage in 2002.

a. $8.06
b. $8.13
c. $13.00
d. $20.80

18. If the CPI increases from 100 to 200 and the nominal wage increases from
$100 to $400, what is the change in the real wage in terms of the beginning
year’s dollars?
a. $200
b. $400
c. $100
d. –$200

19. The real interest rate on a loan

a. is the amount that the consumer agrees to pay.
b. is always the same as the nominal rate.
c. is the percentage increase in the lender’s purchasing power that results from
making the loan.
d. decreases as the inflation rate increases.

20. If a lender wants a real return of 6 percent and she expects inflation to be
4 percent, which of the following is the nominal interest rate to charge?
a. 4 percent
b. 6 percent
c. 2 percent
d. 10 percent

21. Suppose that a labor union leader is trying to bargain for an increase in
union workers’ real wages of 5 percent. If she expected the price level to rise
at a rate of 3 percent this year, how much would nominal wages need to
increase for her to accomplish her objective?
a. 2 percent
b. 3 percent
c. 5 percent
d. 8 percent
22. When borrowing money to purchase an automobile, Wei has the choice
between a fixed nominal interest rate or adjustable nominal interest rate loan.
Typically the adjustable rate loans start with a lower rate than the fixed rate
loans. Given that, Wei would most likely want to borrow money at the higher
fixed rate when she 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.

23. If you borrow money at a nominal interest rate of 5 percent and the
inflation rate is 10 percent, what real interest rate will you pay?
a. –5 percent
b. .5 percent
c. 2 percent
d. 10 percent

24. 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.

25. In general, a higher-than-anticipated inflation rate

a. helps everyone.
b. hurts everyone.
c. helps creditors and harms debtors.
d. helps debtors and harms creditors