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answerstohomework2spring2007 - Economics 302 Spring 2007...

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Economics 302 Spring 2007 Answer Key: Homework 2 Collected February 20 1. a. Using 2003 as base year, the market basket would be the consumption basket of the typical or average consumer in that year. Since there are two consumers, we just divide the aggregate consumption (or consumer goods) in 2003 by two. Thus, the market basket is 5 canisters of cheeseballs and 1.5 TVs. The resulting consumer price index is as follows: Year Current value of market basket 2003 value of market basket CPI 2003 477.50 \$ 477.5 1.00 2004 471.00 \$ 477.5 0.99 2005 465.50 \$ 477.5 0.97 2006 462.00 \$ 477.5 0.97 b. Year Current value of market basket 2003 value of market basket CPI 2003 320.00 \$ 310.2 1.03 2004 315.80 \$ 310.2 1.02 2005 312.40 \$ 310.2 1.01 2006 310.20 \$ 310.2 1.00 c. Nominal GDP Real GDP GDP Deflator 12,505 \$ 22,224 \$ 0.56 17,222 \$ 23,750 \$ 0.73 20,260 \$ 22,017 \$ 0.92 20,570 \$ 20,570 \$ 1.00 d. Surprisingly, since we usually think that the CPI should overstate inflation while the deflator will understate it, we find in this case that the CPI measure for inflation is much lower than what the GDP deflator would suggest. The reason is that in this economy, only firms consume oil and oil is the main source of inflation in the economy.

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