Chapter 24 Study Guide

Multiple Choice
1. In the CPI, goods and services are weighted according to
 * a. how long a market has existed for each good or service.


 * b. the extent to which the government regards each good or service as a necessity.


 * c. how much consumers buy of each good or service.


 * d. the number of firms that produce and sell each good or service.

2. For any given year, the CPI is the price of the basket of goods and services in the
 * e. the extend to which each good or service is involved in creating jobs in the economy.


 * a. given year divided by the price of the basket in the base year, then multiplied by 100.


 * b. given year divided by the price of the basket in the previous year, then multiplied by 100.


 * c. base year divided by the price of the basket in the given year, then multiplied by 100.


 * d. previous year divided by the price of the basket in the given year, then multiplied by 100.

3. The inflation rate is calculated
 * e. given year minus the price in the previous year.
 * a. by determining the change in the price index from the preceding period.


 * b. by adding up the price increases of all goods and services.


 * c. by computing a simple average of the price increases for all goods and services.


 * d. by determining the percentage increase in the price index from the preceding period.

4. For an imaginary economy, the value of the consumer price index was 140 in 2006 and 149.1 in 2007. The economy’s inflation rate for 2007 was
 * e. by subtracting the CPI numbers from two consecutive years.
 * a. 6.1 percent.


 * b. 6.5 percent.


 * c. 9.1 percent.


 * d. 49.1 percent.

5. Which of the following changes in the price index produces the greatest rate of inflation: 106 to 112, 112 to 118, 118 to 124, or 124 to 130?
 * e. 140 percent.
 * a. 106 to 112


 * b. 112 to 118


 * c. 118 to 124


 * d. 124 to 130

6. Suppose that in 2010, the producer price index increases by 2 percent. As a result, economists most likely will predict that
 * e. All of these changes produce the same rate of inflation.
 * a. GDP will increase in 2011.


 * b. the producer price index will increase by more than 2 percent in 2011.


 * c. interest rates will decrease in the future.


 * d. the consumer price index will increase in the future.

7. One of the widely acknowledged problems with using the consumer price index as a measure of the cost of living is that the CPI
 * e. the consumer price index will decrease in the future.
 * a. fails to account for consumer spending on housing.


 * b. accounts only for consumer spending on food, clothing, and energy.


 * c. fails to account for the fact that consumers spend larger percentages of their incomes on some goods and smaller percentages of their incomes on other goods.


 * d. fails to account for the introduction of new goods.

8. When the quality of a good improves while its price remains the same, the purchasing power of the dollar
 * e. fails to account for recent large increases in energy prices.
 * a. increases, so the CPI overstates the change in the cost of living if the quality change is not accounted for.


 * b. increases, so the CPI understates the change in the cost of living if the quality change is not accounted for.


 * c. decreases, so the CPI overstates the change in the cost of living if the quality change is not accounted for.


 * d. decreases, so the CPI understates the change in the cost of living if the quality change is not accounted for.

9. An important difference between the GDP deflator and the consumer price index is that
 * e. remains the same as these two forces offset each other.
 * a. the GDP deflator reflects the prices of goods and services bought by producers, whereas the consumer price index reflects the prices of goods and services bought by consumers.


 * b. the GDP deflator reflects the prices of all final goods and services produced domestically, whereas the consumer price index reflects the prices of goods and services bought by consumers.


 * c. the GDP deflator reflects the prices of all final goods and services produced by a nation’s citizens, whereas the consumer price index reflects the prices of all final goods and services bought by consumers.


 * d. the GDP deflator reflects the prices of all final goods and services bought by producers and consumers, whereas the consumer price index reflects the prices of all final goods and services bought by consumers.

10. Julie earned a salary of $60,000 in 2001 and $80,000 in 2006. The consumer price index was 177 in 2001 and 221.25 in 2006. Julie’s salary
 * e. the GDP deflator reflects the prices of intermediate goods and services bought by producers and consumers, whereas the consumer price index reflects the prices of all final goods and services bought by producers and consumers.
 * a. increased in nominal dollars but decreased in real dollars.


 * b. increased in real dollars but decreased in nominal dollars.


 * c. increased in both nominal and real dollars.


 * d. decreased in both nominal and real dollars.

11. Which of the following statements is correct about the relationship between the nominal interest rate and the real interest rate?
 * e. increased in nominal dollars and remained the same in real dollars.
 * a. The real interest rate is the nominal interest rate times the rate of inflation.


 * b. The real interest rate is the nominal interest rate minus the rate of inflation.


 * c. The real interest rate is the nominal interest rate plus the rate of inflation.


 * d. The real interest rate is the nominal interest rate divided by the rate of inflation.

12. Suppose that over the past year, the real interest rate was 5 percent and the inflation rate was 3 percent. It follows that
 * e. The real interest rate is always higher than the nominal interest rate.
 * a. the dollar value of savings increased at 5 percent, and the purchasing power of savings increased at 2 percent.


 * b. the dollar value of savings increased at 5 percent, and the purchasing power of savings increased at 8 percent.


 * c. the dollar value of savings increased at 8 percent, and the purchasing power of savings increased at 2 percent.


 * d. the dollar value of savings increased at 8 percent, and the purchasing power of savings increased at 5 percent.


 * e. the dollar value of savings increased at 8 percent, and the purchasing power of savings decreased by 5 percent.

Answers

 * C
 * A
 * D
 * B
 * A
 * D
 * D
 * A
 * B
 * C
 * B
 * D

Free Response
1. Jay and Joyce meet George, the banker, to work out the details of a mortgage. They all expect that inflation will be 2 percent over the term of the loan, and they agree on a nominal interest rate of 6 percent. As it turns out, the inflation rate is 5 percent over the term of the loan.


 * a. What was the expected real interest rate?


 * b. What was the actual real interest rate?


 * c. Who benefited and who lost because of the unexpected inflation?

2. In a simple economy, people consume only two goods, food and clothing. The market basket of goods used to compute the CPI consists of fifty units of food and ten units of clothing.
 * a. What are the percentage increases in the price of food and in the price of clothing?


 * b. What is the percentage increase in the CPI?


 * c. Do these price changes affect all consumers to the same extent? Explain.