(a) Calculate the Consumer Price Index (CPI) for Country A in 2016.
2015 (Basket of Goods)
5.6 x 25 + 3.45 x 18 + 1.2 x 40 + 8.40 x 5 + 2.55 x 12 = 322.70
2016 (Basket of Goods)
6.3 x 25 + 3.5 x 18 + 1.05 x 40 + 9.20 x 5 + 2.35 x 12 = 336.70
Understand that the base year CPI is 100 and the rate of change for inflation from 2015 to 2016 was 4.34%
To find the rate of change use the formula
(New – Old) / Old x 100 = (Change in Inflation)
336.70 – 322.70 / 322.70 x 100 = 4.34%
or
New/ Old x 100 = CPI in 2016
2016/ 2015 x 100 = CPI in 2016
336.70/322.70 x 100 = 104.34
(b) State two reasons why the CPI may not accurately reflect changes in the cost of living for citizens of Country A.
· Different income earners may experience different consumption patterns, college students would be hit harder for clothing that senior citizens and senior citizens will be hit harder by increases in medical costs.
· Consumption patterns change frequently, if the costs of certain items increase people can switch to cheaper goods ubstitution bias
· Wide regional differences in prices, the cost of housing in San Francisco CA, is much higher than Columbia SC.·
· Substitution Bias – when consumers choose to substitute one good for another after its price becomes cheaper than the good they normally buy.
· Quality Bias – over time, technological advances increase the life and/or the usefulness of products.
· Outlet Bias – consumers shift to new shopping areas such as wholesale clubs or online retailers that are not well represented by the CPI.
(a) (i) Using the data in Table 2 to support your answer, identify one year in which Country B experienced deflation and one year in which Country B experienced Disinflation.
The CPI decreased from 2008 (98) to (97) in 2009. = Deflation
Deflation = is the sustained decrease in the Average Price Level or the idea that deflation is a decrease in the prices of goods and services.
Disinflation = refers to a decrease in the rate of the increase of the Average Price Level or a decrease in the rate of inflation.
Disinflation was experienced between 2011 and 2012 as the rate of increase in the CPI (4.55%) was lower than the previous years inflation increase of 10%.
Remember – Rate of Change Formula = (New-old)/ old x 100
(ii) In Country B, Nominal GDP (per capita) is $800 per month in 2010 and $940 per month in 2012. Using the CPI in Table 2 as a deflator, calculate the percentage change in the real (per capita) GDP from 2010 to 2012.
To go from Nominal to Real
The rate of inflation from 2010 (base year) to 2012 = 15%
RGDP = (NGDP/Price Index) x 100
817.39 = ($940/115) x 100
Understand that the Nominal = Real in the Base year (as there is no inflation)
Rate of Change = (New – Old) / Old x 100
2.17% = (817.39 - 800) / 800 x 100
(a) Using an AD/AS diagram, explain one reason why deflation may lead to a higher level of unemployment.
Vertical Axis may be PL, APL or inflation
Horizontal Axis may be output, real output, national output, real national output, national income (Y) or GDP
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