1. Calculating inflation using a simple price index Consider a fictional price i
ID: 1221187 • Letter: 1
Question
1. Calculating inflation using a simple price index Consider a fictional price index, the College Student Price Index (CSPI), based on a typical college student's annual purchases. Suppose the following table shows information on the market basket for the CSPI and the prices of each of the goods in 2010, 2011, and 2012 The cost of each item in the basket and the total cost of the basket are shown for 2010 Perform these same calculations for 2011 and 2012, and enter the results in the following table 2010 2011 2012 Price Cost Price Cost Price Cost Quantity in Basket (Dollars) (Dollars) (Dollars) (Dollars) (Dollars) (Dollars) Notebooks Calculators Large coffees Energy drinks Textbooks Total cost Price index 30 75 600 150 720 1,575 100 10 3 80 2 4 110 4 75 104 300 75 8 90 120Explanation / Answer
The table has been constructed in the same way as the first column has been provided in the example. Multiply the cost with the base year quantity.
2010
2011
2012
Quantity
Price
Cost
Quantity
Price
Cost
Quantity
Price
Cost
Notebooks
10
3
30
10
3
30
10
4
40
calculators
1
75
75
1
80
80
1
104
104
large coffees
300
2
600
300
2
600
300
2
600
energy drinks
75
2
150
75
4
300
75
5
375
textbook
8
90
720
8
110
880
8
120
960
Total
1575
1890
2079
Index
100
120
132
The price index can be computed as: [(Cost in the current year - Cost in the base year)/Cost in the base year]*100
So this implies that the increase in the price index for 2011 = [(1890 - 1575)/1575]*100 = 20. So that Insex value rise by 20 points to become 120. Similarly, price index for 2012 is 132.
So increase in the CSPI between 2010 and 2011 is (120-100)/100 = 20%
And increase in the CSPI between 2011 and 2012 is (132-120)/120 = 10%
It is a tendency among the consumers to search for the lowest prices for the commodities they buy. This leads to Outlet Substitution Bias where consumers do not hesitate in driving to other outlets situated far away in search for the lowest prices. Commodity Substitution Bias can occur when consumers replace the old commodity they were using and start purchasing its closest substitute just because the price of the former has risen. CPI does not count these biases and hence overstates the rise in prices
So correct option is A.
2010
2011
2012
Quantity
Price
Cost
Quantity
Price
Cost
Quantity
Price
Cost
Notebooks
10
3
30
10
3
30
10
4
40
calculators
1
75
75
1
80
80
1
104
104
large coffees
300
2
600
300
2
600
300
2
600
energy drinks
75
2
150
75
4
300
75
5
375
textbook
8
90
720
8
110
880
8
120
960
Total
1575
1890
2079
Index
100
120
132
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