Question

1. As an example of a price index, consider the A.C.D.P.I. (a fictitious price index). The
associated basket of goods is:
Good Quantity Price
Coffee 3 lb $8/lb
Bread 3 loaves $1/loaf
Tea 1 lb $15/lb
Aspirin 1 200-tablet bottle $2/bottle
Cola 1 case $6/case

A. If the price of coffee doubles, what is the resulting percentage change in the
price level? (2 points)

B. If the price of bread doubles, what is the resulting percentage change in the
price level? (2 points)

C. Why is the effect of a 100% increase in the price of coffee so much greater
than the effect of a similar change in the price of bread? (4 points)

D. Assume that the mix of goods in a basket is kept constant for long periods. If
the price of one good rises very rapidly over several years, what will happen to
the relative importance of the other goods in the basket? Is this a problem? (6
points)

E. If the price of coffee increases, we get a positive rate of inflation, even if no
other price rises. Is this really inflation? Explain. (6 points)

Answer 1

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