section7 - Department of Economics University of California...

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Department of Economics University of California, Berkeley Econ 100A, Sections 104 and 108 GSI: Ana Rocca Section 7 1 Cost of Living Indices 1.1 Ideal Cost of Living Index Rachel and Sarah are sisters with identical preferences. When Sarah went to college in 1999, her parents gave her a budget of $500 per quarter. Sarah used this budget to buy 100 pounds of food at a price of $2 per pound, and 15 books, at a price of $20 each. Ten years later, Rachel is about to start college. In 2009, food cost $2.20 per pound and books $100 each. Rachel’s father wants to be fair, so he wants to give Rachel a budget that is equivalent in buying power to the budget given to her older sister. How can he do this? Ideal cost-of-living index: Cost of attaining a given level of utility at current prices relative to the cost of attaining the same utility at base-year prices. In the previous example, the current year prices are the prices in 2009 and the base year is 1999.
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