Inflation
Problem Set
1. Over the last year, Eli has been working very hard and his 5. If the cost of a market basket is $200 in Year 1 and $230 in
employer has taken notice by giving him a 6% raise in his Year 2, the price index for Year 2 with a Year 1 base is:
salary. During this last year, overall prices in the A. 100.
economy have increased by 4%. Given this information, B. 90.
Eli's real wage has: C. 130.
A. stayed constant. D. 200.
B. increased by 6%. E. 115.
C. increased by 10%.
D. decreased by 4%. 6. If the CPI is 120 in Year 1 and 150 in Year 2, then the rate
E. increased by 2%. of inflation from Year 1 to Year 2 is _____.
A. 10%
2. If the actual inflation rate is less than the expected B. 20%
inflation rate, then: C. 25%
A. there are higher menu costs due to the lower actual D. 50%
inflation. E. 100%
B. the borrowers gain and the lenders lose.
C. everyone benefits from the lower actual inflation. 7. If the consumer price index changes from 120 to 125
D. everyone is worse off from the lower actual inflation. between December 2007 and December 2008, the:
E. the lenders gain and the borrowers lose. A. inflation rate for 2008 is 4.2%.
B. inflation rate for 2008 is 5%.
3. Suppose that a bank wishes to make a 5% rate of return C. deflation rate for 2008 is 5%.
on a one-year loan but expects that inflation over the D. deflation rate for 2008 is –4.2%.
course of the loan will be roughly 3%. Which of the E. inflation rate for 2008 is 10%.
following is true?
A. As long as the bank charges a nominal interest rate of at 8. You read in the newspaper that the CPI in 2008 was 120,
least 5%, it will earn its expected return. you will conclude that a typical market basket in 2008
B. If the bank charges an interest rate of 8% or higher, this would have cost
will guarantee it to earn the expected return. A. 20 percent more than the same market basket purchased
C. If the bank charges 8% and the inflation rate is less than in 2007.
3%, then the bank will have earned a larger rate of return B. 120 percent more than the same market basket
than expected. purchased in 2007.
D. If the bank charges 8% and the inflation rate is more than C. 20 percent more than the same market basket purchased
3%, then the bank will have earned a larger rate of return in the base year.
than expected. D. 120 percent more than the same market basket
E. As long as the bank charges a nominal interest rate of purchased in the base year.
3%, it will earn its expected return. E. 20 percent less than the same market basket purchased
in the base year.
4. You have gone to the bank to borrow money for one year.
The nominal rate is 7.5%. The real rate of interest is 4%.
Over the course of the year, overall prices increased by
4%. This rate of inflation hurt the _____ because the
actual rate of inflation was _____ than the anticipated rate
of inflation.
A. borrower; lower
B. borrower; higher
C. lender; higher
D. lender; lower
E. lender; equal to
9. Eastland College is concerned about the rising price of 2012 2013 2014
textbooks that students must purchase. To better identify the English textbook $50 $55 $57
increase in the price of textbooks, the dean asks you, the Math textbook $70 $72 $74
Economics Department’s start student, to create an index of Economics textbook $80 $90 $100
textbook prices. The average student purchases three
English, two math, and four economics textbooks. The
prices of these books are given in the table.
a. What is the percent change in the price of an English textbook from 2012 to 2014?
b. What is the percent change in the price of a math textbook from 2012 to 2014?
c. What is the percent change in the price of an economics textbook from 2012 to 2014?
d. Using 2012 as a base year, create a price index for these books for all years.
e. What is the percent change in the price index from 2012 to 2014?
Market Basket = 200 oranges, Market Basket = 100 oranges,
50 grapefruit, 100 lemons 50 grapefruit, 200 lemons
Pre-Frost Post-Frost Pre-Frost Post-Frost
Price of oranges $0.20 $0.40 $0.20 $0.40
Price of grapefruits $0.60 $1.00 $0.60 $1.00
Price of lemons $0.25 $0.45 $0.25 $0.45
Cost of market basket $95.00 $175.00
Price index 100 184.2
10. Consider the data in the table above. Suppose that the market basket is composed of 100 oranges, 50 grapefruit, and
200 lemons. How does this change the pre-frost and post-frost price indexes? Explain. Generalize your explanation to
how the construction of the market basket affects the price index.
11. Suppose that the year you were born someone bought $100 of goods and services for your baby shower. How much
would you guess it would cost today to buy a similar amount of goods and services? Now find data on the consumer
price index and computer the answer based on it. (You can find the BLS’s inflation calculator here:
[Link]
12. The residents of Vegopia spend all of their income on cauliflower, broccoli, and carrots. In 2013, they buy 100 heads of
cauliflower for $200, 50 bunches of broccoli for $75, and 500 carrots for $50. In 2014, they buy 75 heads of cauliflower
for $225, 80 bunches of broccoli for $120, and 500 carrots for $100.
a. Calculate the price of each vegetable in each year.
Year Cauliflower Broccoli Carrots
2013
2014
b. Using 2013 as the base year, calculate the CPI for each year.
c. What is the inflation rate in 2014?
13. The consumer price index in the United States (base period 1982-1984) was 229.6 in 2012 and 233 in 2013. Calculate
the inflation rate from 2012 to 2013.