ECON 214 HW11 Inflation Assignment solutions complete answers

ECON 214 HW11 Inflation Assignment solutions complete answers

 

1. Calculating inflation using a simple price index

Consider an imaginary price index, the Undergraduate Price Index (UPI), created to represent the annual purchases made by a typical undergradute. The following table contains information on the market basket for the UPI and the price of each good in 2020, 2021, and 2022.

The cost of each good in the basket as well as the basket’s total cost are given for 2020.

Perform these same calculations for 2021 and 2022, and enter the results in the following table.

 
Quantity in Basket
2020
2021
2022
Price
Cost
Price
Cost
Price
Cost
(Dollars)
(Dollars)
(Dollars)
(Dollars)
(Dollars)
(Dollars)
Streaming services
1
64
64
104
104
134
134
Iced coffees
150
2
300
2
 
2
 
Textbooks
10
80
800
85
 
105
 
Notebooks
8
2
16
2
 
4
 
Energy drinks
40
3
120
4
 
5
 
Total cost
 
 
1,300
 
 
 
 
Price index
 
 
100
 
 
 
 
 

Between 2020 and 2021, the UPI increased by 10%. Between 2021 and 2022, the UPI increased by 20%.

 

Which of the following, if true, would illustrate why price indexes such as the UPI might overstate inflation in the cost of going to college? Check all that apply.

 As the price of energy drinks increased relative to the price of coffee between 2020 and 2022, students decreased their consumption of energy drinks and increased their consumption of coffee.

 The quality of textbooks increased dramatically from 2020 to 2022, with textbook companies bundling new online study aids with their books, but this quality change is hard to measure.

 Professors required each student to buy eight notebooks, regardless of the price.

 An app-based scooter company, which made it easier to get around places like college campuses, became available for rental.

 

Consider an imaginary price index, the Undergraduate Price Index (UPI), created to represent the annual purchases made by a typical undergradute. The following table contains information on the market basket for the UPI and the price of each good in 2020, 2021, and 2022.

The cost of each good in the basket as well as the basket’s total cost are given for 2020.

Perform these same calculations for 2021 and 2022, and enter the results in the following table.

 
Quantity in Basket
2020
2021
2022
Price
Cost
Price
Cost
Price
Cost
(Dollars)
(Dollars)
(Dollars)
(Dollars)
(Dollars)
(Dollars)
Streaming services
1
64
64
104
 
134
 
Iced coffees
150
2
300
2
 
2
 
Textbooks
10
80
800
85
 
105
 
Notebooks
8
2
16
2
 
4
 
Energy drinks
40
3
120
4
 
5
 
Total cost
 
 
1,300
 
 
 
 
Price index
 
 
100
 
 
 
 
Suppose this price index uses 2020 as the base year.

In the last row of the table, calculate and enter the value of the UPI for the remaining years.

Between 2020 and 2021, the UPI increased by

 

. Between 2021 and 2022, the UPI increased by

 

.

Which of the following, if true, would illustrate why price indexes such as the UPI might overstate inflation in the cost of going to college? Check all that apply.

 As the price of textbooks increased, more and more students turned to the used-book market or chose not to buy textbooks at all, instead using the copies on reserve in the library.

 The quality of content provided by streaming services improved dramatically from 2020 to 2022. Many companies invested heavily in the actors cast for their original series, but this quality change is hard to measure.

 Professors required each student to buy eight notebooks, regardless of the price.

 A natural dietary supplement is developed that is clinically proven to safely boost memory.

 

Perform these same calculations for 2021 and 2022, and enter the results in the following table.

 
Quantity in Basket
2020
2021
2022
Price
Cost
Price
Cost
Price
Cost
(Dollars)
(Dollars)
(Dollars)
(Dollars)
(Dollars)
(Dollars)
Streaming services
1
70
70
100
 
130
 
Iced coffees
250
2
500
2
 
2
 
Textbooks
10
120
1,200
150
 
180
 
Notebooks
15
2
30
5
 
8
 
Energy drinks
50
2
100
4
 
6
 
Total cost
 
 
1,900
 
 
 
 
Price index
 
 
100
 
 
 
 
Suppose this price index uses 2020 as the base year.

In the last row of the table, calculate and enter the value of the UPI for the remaining years.

Between 2020 and 2021, the UPI increased by

 

. Between 2021 and 2022, the UPI increased by

 

.

Which of the following, if true, would illustrate why price indexes such as the UPI might overstate inflation in the cost of going to college? Check all that apply.

 Energy drinks became increasingly popular on college campuses between 2020 and 2022 due to significant improvements in flavor, but this quality change is hard to measure.

 Professors required each student to buy 10 textbooks, regardless of the price.

 As the price of premium streaming services rose, fewer students decided to buy them, opting instead to borrow log-in information from friends and relatives.

 A new, cheaper internet option rolled out services nationwide.

 

2. Alternative price indexes

Because there isn't one single measure of inflation, the government and researchers use a variety of methods to get the most balanced picture of how prices fluctuate in the economy. Two of the most commonly used price indexes are the consumer price index (CPI) and the GDP deflator.

The CPI for this year is calculated by dividing the using  by the using  and multiplying by 100. However, the GDP deflator reflects only the prices of all goods and services.

 

Indicate whether each scenario will affect the GDP deflator or the CPI for the United States. Check all that apply.

Scenario
Shows up in the...
GDP Deflator
CPI
A decrease in the price of a Italian-made motorcycle that is popular among U.S. consumers
 
 
 
An increase in the price of a Smooth Streets Industries pothole puncher, which is commercial construction equipment made in the U.S. but not bought by U.S. consumers
 
 
 
 

 

Because there isn't one single measure of inflation, the government and researchers use a variety of methods to get the most balanced picture of how prices fluctuate in the economy. Two of the most commonly used price indexes are the consumer price index (CPI) and the GDP deflator.

The GDP deflator for this year is calculated by dividing the  using  by the using  and multiplying by 100. However, the CPI reflects only the prices of all goods and services.

 

Indicate whether each scenario will affect the GDP deflator or the CPI for the United States. Check all that apply.

Scenario
Shows up in the...
GDP Deflator
CPI
A decrease in the price of a Rivertown Ltd. depths dredger, which is a commercial mining product used for underwater mineral extraction, made in the U.S., but not bought by U.S. consumers
 
 
 
An increase in the price of a Scandinavian-made furniture that is popular among U.S. consumers
 
 
 
 

The GDP deflator for this year is calculated by dividing the     using      by the     using      and multiplying by 100. However, the CPI reflects only the prices of all goods and services    .

Indicate whether each scenario will affect the GDP deflator or the CPI for the United States. Check all that apply.

Scenario
Shows up in the...
GDP Deflator
CPI
An increase in the price of a South Korean-made furniture that is popular among U.S. consumers
 
 
 
A decrease in the price of a Smooth Streets Industries pothole puncher, which is commercial construction equipment made in the U.S. but not bought by U.S. consumers
 
 
 
 

Because there isn't one single measure of inflation, the government and researchers use a variety of methods to get the most balanced picture of how prices fluctuate in the economy. Two of the most commonly used price indexes are the consumer price index (CPI) and the GDP deflator.

The CPI for this year is calculated by dividing the     using      by the     using      and multiplying by 100. However, the GDP deflator reflects only the prices of all goods and services    .

Indicate whether each scenario will affect the GDP deflator or the CPI for the United States. Check all that apply.

Scenario
Shows up in the...
GDP Deflator
CPI
A decrease in the price of a Scandinavian-made motorcycle that is popular among U.S. consumers
 
 
 
An increase in the price of a Rivertown Ltd. depths dredger, which is a commercial mining product used for underwater mineral extraction, made in the U.S., but not bought by U.S. consumers
 
 
 
 

The GDP deflator for this year is calculated by dividing the     using      by the     using      and multiplying by 100. However, the CPI reflects only the prices of all goods and services    .

Indicate whether each scenario will affect the GDP deflator or the CPI for the United States. Check all that apply.

Scenario
Shows up in the...
GDP Deflator
CPI
An increase in the price of a Smooth Streets Industries pothole puncher, which is commercial construction equipment made in the U.S. but not bought by U.S. consumers
 
 
 
A decrease in the price of a Italian-made coffee maker that is popular among U.S. consumers
 
 
 
 

3. Comparing salaries from different times

Consider golfers who led the Professional Golfers’ Association of America (PGA) in winnings at different points in time. Note that the winnings are nominal figures (unadjusted for inflation).

To convert the original earnings of Casper, Nicklaus, and Kite, use the formula for converting dollar figures from an earlier era into year 2016 U.S. dollars. Using those figures, fill in the following table, making sure to round your responses to the nearest U.S. dollar.

Year
Golfer
Nominal Winnings
U.S. CPI
Winnings in 2016 Dollars
(Dollars)
(1983 = 100)
1968
Billy Casper
205,169
34.8
 
1973
Jack Nicklaus
308,362
44.4
 
1981
Tom Kite
375,699
90.9
 
2016
Dustin Johnson
9,365,185
240.0
 
 

True or False: According to the previous table, the golfer with the highest PGA winnings in nominal dollars is not the same as the golfer with the highest PGA winnings after adjusting for inflation.

 

To convert the original earnings of Nicklaus, Trevino, and Stadler, use the formula for converting dollar figures from an earlier era into year 2017 U.S. dollars. Using those figures, fill in the following table, making sure to round your responses to the nearest U.S. dollar.

Year
Golfer
Nominal Winnings
U.S. CPI
Winnings in 2017 Dollars
(Dollars)
(1983 = 100)
1965
Jack Nicklaus
140,752
31.5
    
1970
Lee Trevino
157,037
38.8
    
1982
Craig Stadler
446,462
96.5
    
2017
Justin Thomas
9,921,560
245.1
9,921,560
True or False: According to the previous table, the golfer with the highest PGA winnings in nominal dollars is not the same as the golfer with the highest PGA winnings after adjusting for inflation.

 True

 False

 

To convert the original earnings of Casper, Watson, and Kite, use the formula for converting dollar figures from an earlier era into year 2021 U.S. dollars. Using those figures, fill in the following table, making sure to round your responses to the nearest U.S. dollar.

Year
Golfer
Nominal Winnings
U.S. CPI
Winnings in 2021 Dollars
(Dollars)
(1983 = 100)
1968
Billy Casper
205,169
34.8
    
1980
Tom Watson
530,808
82.4
    
1981
Tom Kite
375,699
90.9
    
2021
John Rahm
7,705,933
264.7
7,705,933
True or False: According to the previous table, the golfer with the highest PGA winnings in nominal dollars is the same as the golfer with the highest PGA winnings after adjusting for inflation.

 True

 False

 

To convert the original earnings of Nelson, Miller, and Norman, use the formula for converting dollar figures from an earlier era into year 2016 U.S. dollars. Using those figures, fill in the following table, making sure to round your responses to the nearest U.S. dollar.

Year
Golfer
Nominal Winnings
U.S. CPI
Winnings in 2016 Dollars
(Dollars)
(1983 = 100)
1945
Byron Nelson
63,336
18
    
1974
Johnny Miller
353,022
49.3
    
1986
Greg Norman
653,296
109.6
    
2016
Dustin Johnson
9,365,185
240.0
9,365,185
True or False: According to the previous table, the golfer with the highest PGA winnings in nominal dollars is the same as the golfer with the highest PGA winnings after adjusting for inflation.

 True

 False

 

4. Inflation and interest rates

The following table gives the average nominal interest rates on six-month Treasury bills spanning the years 2004 and 2008, which determined the nominal interest rate paid by the U.S. government when it issued debt in that time period. The table also gives the inflation rate for the years 2004 to 2008. (All rates rounded to the nearest 0.1 percent.)

Year
Nominal Interest Rate
Inflation Rate
(Percent)
(Percent)
2004
1.6
2.7
2005
3.4
3.4
2006
4.8
3.2
2007
4.4
2.9
2008
1.6
3.8
Source: “FRED Economic Data,” Federal Reserve Bank of St. Louis, last modified September 23, 2019, accessed September 24, 2019, https://fred.stlouisfed.org.

On the following graph, use the orange points (square symbol) to plot the nominal interest rates for the years 2004 to 2008. Next, use the green points (triangle symbol) to plot the real interest rates for those years.

 

According to the table, in which year did buyers of six-month Treasury bills receive the highest real return on their investment?

 2004

 2005

 2006

 2007

 2008

 

The following table gives the average nominal interest rates on six-month Treasury bills spanning the years 1971 and 1975, which determined the nominal interest rate paid by the U.S. government when it issued debt in that time period. The table also gives the inflation rate for the years 1971 to 1975. (All rates rounded to the nearest 0.1 percent.)

Year
Nominal Interest Rate
Inflation Rate
(Percent)
(Percent)
1971
4.5
4.2
1972
4.5
3.3
1973
7.2
6.3
1974
8.0
11.0
1975
6.1
9.1
Source: “FRED Economic Data,” Federal Reserve Bank of St. Louis, last modified September 23, 2019, accessed September 24, 2019, https://fred.stlouisfed.org.

On the following graph, use the orange points (square symbol) to plot the nominal interest rates for the years 1971 to 1975. Next, use the green points (triangle symbol) to plot the real interest rates for those years.

Nominal Interest RateReal Interest Rate19701971197219731974197519768.07.06.05.04.03.02.01.00-1.0-2.0-3.0INTEREST RATE (Percent)YEAR

According to the table, in which year did buyers of six-month Treasury bills receive the highest real return on their investment?

 1971

 1972

 1973

 1974

 1975

 

The following table gives the average nominal interest rates on six-month Treasury bills spanning the years 1997 and 2001, which determined the nominal interest rate paid by the U.S. government when it issued debt in that time period. The table also gives the inflation rate for the years 1997 to 2001. (All rates rounded to the nearest 0.1 percent.)

Year
Nominal Interest Rate
Inflation Rate
(Percent)
(Percent)
1997
5.2
2.3
1998
4.8
1.5
1999
4.8
2.2
2000
5.9
3.4
2001
3.4
2.8
Source: “FRED Economic Data,” Federal Reserve Bank of St. Louis, last modified September 23, 2019, accessed September 24, 2019, https://fred.stlouisfed.org.

On the following graph, use the orange points (square symbol) to plot the nominal interest rates for the years 1997 to 2001. Next, use the green points (triangle symbol) to plot the real interest rates for those years.

Nominal Interest RateReal Interest Rate19961997199819992000200120026.05.04.03.02.01.00INTEREST RATE (Percent)YEAR

According to the table, in which year did buyers of six-month Treasury bills receive the highest real return on their investment?

 1997

 1998

 1999

 2000

 2001

 

The following table gives the average nominal interest rates on six-month Treasury bills spanning the years 2004 and 2008, which determined the nominal interest rate paid by the U.S. government when it issued debt in that time period. The table also gives the inflation rate for the years 2004 to 2008. (All rates rounded to the nearest 0.1 percent.)

Year
Nominal Interest Rate
Inflation Rate
(Percent)
(Percent)
2004
1.6
2.7
2005
3.4
3.4
2006
4.8
3.2
2007
4.4
2.9
2008
1.6
3.8
Source: “FRED Economic Data,” Federal Reserve Bank of St. Louis, last modified September 23, 2019, accessed September 24, 2019, https://fred.stlouisfed.org.

On the following graph, use the orange points (square symbol) to plot the nominal interest rates for the years 2004 to 2008. Next, use the green points (triangle symbol) to plot the real interest rates for those years.

Nominal Interest RateReal Interest Rate20032004200520062007200820095.04.03.02.01.00-1.0-2.0-3.0INTEREST RATE (Percent)YEAR

According to the table, in which year did buyers of six-month Treasury bills receive the highest real return on their investment?

 2004

 2005

 2006

 2007

 2008

 

5. Interest, inflation, and purchasing power

Suppose Dalton is a sports fan and buys only football tickets. Dalton deposits $2,000 into a savings account that pays an annual nominal interest rate of 10%. Assume this interest rate is fixed, and so it will not change over time. On the day she makes her deposit, suppose that a football ticket has a price of $20.00.

Initially, Dalton's $2,000 deposit has a purchasing power of football tickets.

 

For each of the annual inflation rates given in the following table, first determine the new price of a football ticket, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Dalton's deposit after one year in the first row of the table for each inflation rate. Finally, enter the value for the real interest rate at each of the given inflation rates.

Hint: Round your answers in the first row down to the nearest football ticket. For example, if you find that the deposit will cover 20.7 football tickets, you would round the purchasing power down to 20 football tickets under the assumption that Dalton will not buy seven-tenths of a football ticket.

 
Annual Inflation Rate
0%
10%
13%
Number of Tickets Dalton Can Purchase after One Year
 
 
 
Real Interest Rate
 
 
 
 

When the rate of inflation is equal to the interest rate on Dalton's deposit, the purchasing power of her deposit over the course of the year.

 

Suppose Dalton is a fan of young-adult fiction and buys only young-adult books. Dalton deposits $3,000 into a savings account that pays an annual nominal interest rate of 5%. Assume this interest rate is fixed, and so it will not change over time. On the day she makes her deposit, suppose that a young-adult book has a price of $15.00.

Initially, Dalton's $3,000 deposit has a purchasing power of 

 

young-adult books.

For each of the annual inflation rates given in the following table, first determine the new price of a young-adult book, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Dalton's deposit after one year in the first row of the table for each inflation rate. Finally, enter the value for the real interest rate at each of the given inflation rates.

Hint: Round your answers in the first row down to the nearest young-adult book. For example, if you find that the deposit will cover 20.7 young-adult books, you would round the purchasing power down to 20 young-adult books under the assumption that Dalton will not buy seven-tenths of a young-adult book.

 
Annual Inflation Rate
0%
5%
10%
Number of Books Dalton Can Purchase after One Year
    
    
    
Real Interest Rate
 
 
 
When the rate of inflation is less than the interest rate on Dalton's deposit, the purchasing power of her deposit    over the course of the year.

 

Suppose Devon is a fashionista and buys only denim jackets. Devon deposits $4,000 into a savings account that pays an annual nominal interest rate of 10%. Assume this interest rate is fixed, and so it will not change over time. On the day she makes her deposit, suppose that a denim jacket has a price of $20.00.

Initially, Devon's $4,000 deposit has a purchasing power of 

 

denim jackets.

For each of the annual inflation rates given in the following table, first determine the new price of a denim jacket, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Devon's deposit after one year in the first row of the table for each inflation rate. Finally, enter the value for the real interest rate at each of the given inflation rates.

Hint: Round your answers in the first row down to the nearest denim jacket. For example, if you find that the deposit will cover 20.7 denim jackets, you would round the purchasing power down to 20 denim jackets under the assumption that Devon will not buy seven-tenths of a denim jacket.

 
Annual Inflation Rate
0%
10%
13%
Number of Jackets Devon Can Purchase after One Year
    
    
    
Real Interest Rate
 
 
 
When the rate of inflation is equal to the interest rate on Devon's deposit, the purchasing power of her deposit    over the course of the year.

 

Suppose Dariya is a sports fan and buys only football tickets. Dariya deposits $3,000 into a savings account that pays an annual nominal interest rate of 5%. Assume this interest rate is fixed, and so it will not change over time. On the day she makes her deposit, suppose that a football ticket has a price of $10.00.

Initially, Dariya's $3,000 deposit has a purchasing power of 

 

football tickets.

For each of the annual inflation rates given in the following table, first determine the new price of a football ticket, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Dariya's deposit after one year in the first row of the table for each inflation rate. Finally, enter the value for the real interest rate at each of the given inflation rates.

Hint: Round your answers in the first row down to the nearest football ticket. For example, if you find that the deposit will cover 20.7 football tickets, you would round the purchasing power down to 20 football tickets under the assumption that Dariya will not buy seven-tenths of a football ticket.

 
Annual Inflation Rate
0%
5%
8%
Number of Tickets Dariya Can Purchase after One Year
    
    
    
Real Interest Rate
 
 
 
When the rate of inflation is greater than the interest rate on Dariya's deposit, the purchasing power of her deposit    over the course of the year.