Reading 22: Monitoring Cycles, Jobs, and the Price Level - index, style, price

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1.The consumer price index tends to:

A)   overstate the inflation rate, because its market basket is fixed and does not consider that consumers will substitute away from goods that have risen dramatically in price.

B)   overstate the inflation rate because its market basket is variable and takes into consideration that consumers will substitute away from goods that have risen dramatically in price.

C)   understate the inflation rate because its market basket is fixed and does not consider that consumers will substitute away from goods that have risen dramatically in price.

D)   understate the inflation rate because its market basket is variable and takes into consideration that consumers will substitute away from goods that have risen dramatically in price.

2.Steve Walker, CFA, is attending an economics lecture, during which the lecturer makes the following two statements about consumer price inflation:

Statement 1: High-definition televisions are considerably more expensive than traditional models. This means consumers are spending more money per television unit, which represents a form of inflation.

Statement 2: Employment contracts with cost-of-living increases based on the Consumer Price Index result in optimal economic decisions because they adjust wage costs automatically for the rate of inflation.

Should Walker agree or disagree with these statements?

Statement 1

Statement 2

 

A)                    Agree                                     Agree

B)                    Agree                                   Disagree

C)                   Disagree                                Disagree

D)                   Disagree                                  Agree

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答案和详解如下：

1.The consumer price index tends to:

A)   overstate the inflation rate, because its market basket is fixed and does not consider that consumers will substitute away from goods that have risen dramatically in price.

B)   overstate the inflation rate because its market basket is variable and takes into consideration that consumers will substitute away from goods that have risen dramatically in price.

C)   understate the inflation rate because its market basket is fixed and does not consider that consumers will substitute away from goods that have risen dramatically in price.

D)   understate the inflation rate because its market basket is variable and takes into consideration that consumers will substitute away from goods that have risen dramatically in price.

The correct answer was A)

The CPI uses a relatively small market basket and tends to overstate the inflation rate because it does not consider that consumers will substitute away from goods that have risen dramatically in price.

2.Steve Walker, CFA, is attending an economics lecture, during which the lecturer makes the following two statements about consumer price inflation:

Statement 1: High-definition televisions are considerably more expensive than traditional models. This means consumers are spending more money per television unit, which represents a form of inflation.

Statement 2: Employment contracts with cost-of-living increases based on the Consumer Price Index result in optimal economic decisions because they adjust wage costs automatically for the rate of inflation.

Should Walker agree or disagree with these statements?

Statement 1

Statement 2

 

A)                     Agree                                 Agree

B)                     Agree                              Disagree

C)                     Disagree                          Disagree

D)                     Disagree                             Agree

The correct answer was C)

Walker should disagree with both statements. Price changes resulting from increases in the quality of goods, or from consumers choosing to substitute more expensive goods for less expensive ones, do not represent inflation and should not be reflected in price indexes. However, the Consumer Price Index does change based on these and other effects, causing it to overstate the rate of inflation by roughly 1% per year. Bias in the CPI means that it is only an approximation of the actual inflation faced by workers, so both workers’ and employers’ decisions based on CPI-adjusted wages may be less than optimal.

jingh1981

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