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ECON1002 Introductory Macroeconomics, S1 2011
TUTORIAL 2
(Week beginning 14
th
March)
*1. A typical consumer’s food basket in the base year 2000 is as follows:
30 chickens at $3 each
10 hams at $6 each
10 steaks at $8 each
A chicken feed shortage causes the price of chickens to rise to $5 each in the year 2001. Hams rise to $7 each, and
the price of steaks is unchanged.
a. Calculate the change in the ‘costofeating’ index between 2000 and 2001.
The cost of the basket in 2000 is $90 + $60 + $80, or $230. In 2001, the cost is $150 + $70 + $80, or $300. The
official ‘cost of eating’ has increased by ($300 – $230)/$230 or 30.4% between 2000 and 2001.
b. Suppose that consumers are completely indifferent between 2 chickens and 1 ham. For this example, how large is
the substitution bias in the official ‘costofeating’ index?
Since two chickens now cost more than one ham, people will switch from 30 chickens to 15 hams, for a total
ham consumption of 25. The cost of the food basket is now 25 hams at $7.00 plus 10 steaks at $8.00, or
$255. The true increase in the cost of eating is ($255 – $230)/$230, or 10.9%, much lower than the official
estimate of 30.4%. The overestimate of inflation in the cost of eating reflects substitution bias.
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 Three '10
 MarkMelatos
 Macroeconomics

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