# Tutorial 2_2011 _answer for students_ - ECON1002...

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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 ‘cost-of-eating’ 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 ‘cost-of-eating’ 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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## This note was uploaded on 08/18/2011 for the course ECON 1002 taught by Professor Markmelatos during the Three '10 term at University of Sydney.

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Tutorial 2_2011 _answer for students_ - ECON1002...

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