Suppose Natasha consumes two goods: good 1 and good 2. Last year, the price of g

Question

Suppose Natasha consumes two goods: good 1 and good 2. Last year, the price of good 1 was $2.00 and the price of good 2 was $3.20. Given these prices, Natasha maximized satisfaction consuming bundle A, as indicated in the figure to the right. However, this year, the price of good 1 has increased to $6.00 and the price of good 2 has changed to $2.40. Given these prices, Natasha would be equally well off at consumption bundle B Calculate a Laspeyres cost-of-living index for Natasha using 100 as the base for last year. In particular, the Laspeyres index for this year is 1875tour response rounded to two decimal places.) The Laspeyres index suggests inflation has been 87.5 percent over the year. (Enter your response rounded to two decimal places.) The Laspeyres cost-of-iving index overstates the rate of inflation because it assumes that consumers do not alter their consumption patterns as prices change. Natasha's true cost-of-living increase has beenpercent. (Enter your response rounded to two decimal places.) 10 10 20 30 40 50 60 70 80 S0 100 Enter your answer in each of the answer boxes

Explanation / Answer

Laspeyres price index uses base year quantity as weights.

Index = [(P1t*Q1+P2t*Q2) / (P1b*Q1+P2b*Q2)]*100

b- base year(year 1)

t- current year(year 2)

        DefIator = [(6*20 + 2.4*50)/(2*20+3.2*50)]*100 = (240/200)*100 = 120

        InfIation = 120-100 = 20%

      True cost of Iiving increase = 20%

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