econ assign. 3+

# econ assign. 3+ - Assignment#2 Macro 251 November 8 2007...

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Assignment #2 Macro 251 November 8, 2007 Assignment #3 1. CPI A. 3 Problems with CPI Substitution Bias : Over time, some prices rise faster than others so consumers then substitute towards goods that become relatively cheaper. The CPI misses the substitution because is uses a fixed basket of goods which then overstates increases in the cost of living. EX: Poptarts becoming too expensive so people switch to just cereal. Introduction of New Goods : When new goods become available, variety increases which allows consumers to find products that more closely meet their needs. This makes the dollar more valuable and then the CPI misses this effect because it uses a fixed basket. As a result, the CPI overstates increases in the cost of living. EX: iPods introduced and not in basket, CDs still being counted in basket. Unmeasured Quality Change : Improvement in the quality of goods in the basket increases the value of each dollar. The BLS tries to account for quality changes by adjusting the price, but usually misses some quality improvements and thus CPI overstates increases in the cost of living. EX: The price of a TV doesn’t change, but the quality improves. B. The inflation rate is about .5% overstated per year. C. This overestimation affects consumers because social security payments and many contracts have COLAs tied to the CPI, which causes taxpayers to pay more than they need to each year in unnecessary COLAs in social security and govt. pensions. 2. Price of Starter Homes A. P yesterday = P today x ( CPI yest. / CPI today ) 1988: P yest. = \$160,000 x ( 100 / 150 ) = \$106,666.67 2007: P yest. = \$210,000 x ( 100 / 204 ) = \$102,941.18 B. A starter home was most expensive in . In a starter home was least expensive 3. Construction of CPI A. A survey based on the household consumption is done by the Bureau of Labor Statistics to choose the goods and quantities of the basket. B. Typical American Consumption

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i. 2004: (\$3.50 x 365) + (\$2.50 x 150) + (\$.80 x 50) = \$1692.50 2005: (\$3.75 x 365) + (\$3.00 x 150) + (\$.90 x 50) = \$1863.75 2006: (\$4.25 x 365) + (\$3.50 x 150) + (\$1.00 x 50) = \$2126.25 ii. 2004: 100 x ( \$1692.50 / \$1692.50 ) = 100 2005: 100 x ( \$1863.75 / \$1692.50 ) = 110.1 2006: 100 x ( \$2126.25 / \$1692.50 ) = 125.6 iii. 2004 – 2005: ( 110.1 - 100 / 100 ) x 100 = 10.1%
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## This note was uploaded on 04/18/2008 for the course ECON 251 taught by Professor Mattson during the Fall '07 term at St. Thomas.

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econ assign. 3+ - Assignment#2 Macro 251 November 8 2007...

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