Sample+Questions--Midterm+I - Econ 13/IS 13 Sample...

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Econ 13/IS 13 Sample Questions for Midterm 1 1. If the current year CPI is 140, then the price level has increased 40 percent since the base year. TRUE or FALSE? 2. Briefly explain the three major problems in using the CPI as a measure of the cost of living. ANS: (1) Substitution bias. The CPI ignores the fact that consumers substitute toward goods that have become relatively less expensive. (2) Introduction of new goods. Because the CPI uses a fixed basket of goods, it does not take into account the increased well-being of consumers created when new goods are introduced. (3) Unmeasured quality change. Not all quality changes can be measured. 3. Identify the immediate effect of each of the following events on U.S. GDP and its components. a. James receives a Social Security check. b. John buys an Italian sports car. c. Henry buys domestically produced tools for his construction company. ANS: a. Since this is a transfer payment, there is no change to GDP or to any of its components. b. Consumption and imports will rise and cancel each other out. So there is no change in U.S. GDP. c. This increases the investment component of GDP and so increases GDP. 4. In a simple economy, people consume only 2 goods, food and clothing. The market basket of goods used to compute the CPI consists of 50 units of food and 10 units of clothing. a. What are the percentage increases in the price of food and in the price of clothing? b. What is the percentage increase in the CPI? c. Do these price changes affect all consumers to the same extent? Explain. ANS: a. The price of food increased by 50 percent ([6-4]/4 x 100). The price of clothing increased by 100 percent ([20-10]/10 x 100). b. In 2002, the market basket cost $300 (4x50 + 10x10); in 2003, it cost $500 (6x50 + 20x10). The percentage increase in the CPI is 66.7 percent. c. Because the price of clothing increased relatively more than the price of food, people who purchased a lot of clothing and little food became worse off relative to people who purchased a lot of food and little clothing. 5. Which is likely to have the larger effect on the CPI, a 2 percent increase in the price of food or a 3 percent increase in the price of diamond rings? Explain. ANS: The 2 percent increase in the price of food will increase the CPI by more because the portion of the market basket consisting of food is much larger than the portion consisting of diamond rings. 1 Food Clothing 2002 price per unit $4 $10 2003 price per unit $6 $20
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6. Mallory decides to spend three hours working overtime rather than watching a video with her friends. She earns $8 an hour. Her opportunity cost of working is: a. the $24 she earns working.
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Sample+Questions--Midterm+I - Econ 13/IS 13 Sample...

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