CH 6 SOLUTIONS TO TEXTBOOK PROBLEMS Quick Quizzes 1 The...

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CH 6 SOLUTIONS TO TEXTBOOK PROBLEMS Quick Quizzes 1. The consumer price index tries to measure the overall cost of the goods and services bought by a typical consumer. It is constructed by surveying consumers to fix a basket of goods and services that the typical consumer buys, finding the prices of the goods and services over time, computing the cost of the basket at different times, and then choosing a base year. To compute the price index, we divide the cost of the market basket in the current year by the cost of the market basket in the base year and multiply by 100. 2. Since Henry Ford paid his workers $5 a day in 1914 and the consumer price index was 10 in 1914 and 195 in 2005, then the Ford daily paycheque was worth $5 × 195/10 = $97.50 a day in 2005 dollars. Questions for Review 1. A 10 percent increase in the price of chicken has a greater effect on the consumer price index than a 10 percent increase in the price of caviar because chicken is a bigger part of the average consumer's market basket. 2. The three problems in the consumer price index as a measure of the cost of living are: (1) substitution bias, which arises because people substitute toward goods that have become relatively less expensive; (2) the introduction of new goods, which are not reflected quickly in the CPI; and (3) unmeasured quality change. 3. If the price of a military aircraft rises, there is no effect on the consumer price index, since military aircraft are not consumer goods. But the GDP deflator is affected, since military aircraft are included in GDP as a part of government purchases.
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