section2 - Econ 100B Section 101 & 102 Summer 2009 UC...

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Econ 100B Section 101 & 102 Summer 2009 – UC Berkeley Phakawa On Jeasakul June 29, 2009 Practice Problems 1. (Mankiw 2.7) Abby consumes only apples. In year 1, red apples cost $1 each, green apples cost $2 each, and Abby buys 10 red apples. In year 2, red apples cost $2, green apples cost $1, and Abby buys 10 green apples. a. Compute a consumer price index for apples for each year. Assume that year 1 is the base year in which the consumer basket is fixed. How does your index change from year 1 to year 2? Answer: Price index is 1 in year 1, and 2 in year 2. Inflation is 100%. b. Compute Abby’s nominal spending on apples in each year. How does it change from year 1 to year 2? Answer: Nominal spending is $10 in both years. c. Using year 1 as the base year, compute Abby’s real spending on apples in each year. How does it change from year 1 to year 2? Answer: Real spending is 10 year-1 dollar in year 1, and 20 year-1 dollar in year 2. d. Defining the implicit price deflator as nominal spending divided by real spending, compute the deflator for each year. How does the deflator change from year 1 to year 2? Answer: The implicit price deflator is 1 in year 1, and 0.5 in year 2. Inflation is -50%. e. Suppose that Abby is equally happy eating red or green apples. How much has the true cost of living increased for Abby? Compare this answer to your answers to parts (a) and (d). What does this example tell you about Laspeyres and Paasche price indexes? Answer: The true living cost is 10 apples in both years.
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section2 - Econ 100B Section 101 & 102 Summer 2009 UC...

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