1. The consumption bundle and prices for years 0 and 1 for Sam are shown below:

Question

1. The consumption bundle and prices for years 0 and 1 for Sam are shown below:

Item Q0 P0 Q1 P1

Wine 45 $5.00 60 $3.50

Bread 120 $2.00 90 $2.50

a. Using the market basket in year 0 and setting the CPI for year 0 = 1.00, calculate the CPI for year 1

b. Graph the year 0 and year 1 budget constraints. Label the year 0 constraint A and the year 2 constraint B.

c. In which year was Sam better off? How can you tell?

d. Using the market basket in year 1 and pricing it out in year 0 and year 1 prices, what would the value of the CPI be in year 1? (assume the prices in year 0 are set = 1.00 for the CPI)

Explanation / Answer

Market basket in Year 0 = 45 wine + 120 Bread = 45*5 + 120*2 = 225 + 240 = 465
Price in Year 1 for the same basket of year 0 = 45*3.5 + 120*2.5 = 157.5 + 300 = 457.5

CPY for year 1 = CPI Y0 * 457.5/465 = 0.98387097

Sorry there is no option for me to draw, but below are guidelines for you to draw

with wine on x axis and bread on y axis

year 0:

draw a line through 465/5 = 93 on x axis and 465/3.5 = 132.86 on y axis
year 1:
draw a line through 457.5/2 = 228.75 on x axis and 457.5/2.5 = 183 on y axis

Sam is better off in Year 1 due to the lower CPI

Market basket in Year 1 = 60 wine + 90 Bread = 60*3.5 + 90*2.5 = 210 + 225 = 435
Price in Year 0 for the same basket in year 1 = 60 wine + 90 Bread = 60*5 + 90*2 = 300 + 180 = 480

CPI Year 0 =1
then CPI Year1 = 1.00 * 435/480 = 0.90625

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.