Reference no: EM131025354

Practice Questions 5-

I. Multiple Choices:

1) Which of the following statements about the Consumer Price Index (CPI) is not true?

a. The CPI is an index that tracks the prices of all the goods produced in a country during a defined period of time.

b. The CPI is always equal to 100 in the base year.

c. The CPI is used to translate nominal variables into real variables.

d. The CPI tracks the change in the average price level for a set of goods consumers purchase.

2) The CPI in Italy was 150 at the end of year 2000 and 156 at the end of year 2001. What was the inflation rate in Italy in 2001?

a. 6%

b. 4%

c. 2%

d. 56%

3) Consider the following information about the CPI in the country of Myland:

	CPI (base 2000)	CPI (base 2001)
2000	100	84.246
2001	118.7	100

The inflation rate in 2001 computed using the CPI (base 2000) is:

a. Higher than the inflation rate computed using the CPI (base 2001).

b. Lower than the inflation rate computed using the CPI (base 2001).

c. The same as the inflation rate computed using the CPI (base 2001).

d. We don't have enough information to answer this question.

4) At the end of years 2000 and 2001, the CPI (base 1990) in Spain was 140 and 147 respectively. If 2000 is chosen as the base year, the CPI at the end of 2001 is:

a. 100

b. 102

c. 105

d. 110

5) The CPI might overestimate inflation because of any of the following reasons except:

a. The quality of many products and services might improve over time.

b. The CPI is not able to account for periods of deflation.

c. New technologies are introduced in the basket used to compute the CPI only after a lag.

d. People tend to substitute cheaper goods for more expensive ones.

6) Which of the following statements about inflation is true?

a. Inflation always redistributes purchasing power, even if correctly anticipated.

b. Inflation does not affect real variables.

c. People who have to receive future payments will benefit from periods of high and unexpected inflation.

d. People who have to make future payments will benefit from periods of high and unexpected inflation.

7) The Nominal Wage in Canada in 2003 was $ 9.00 and the CPI (base 2000) was 112.5. What was the Real Wage in Canada in 2003, measured in 2000 dollars?

a. $ 8.00

b. $ 8.50

c. $ 9.00

d. $ 10.00

8) The Nominal Wage in Wonderland was $ 10.00 at the end of 2000 and $11.00 at the end of 2001. The inflation rate in 2001 was 4%. From this information we can argue that:

a. The Real Wage has decreased in 2001.

b. The Real Wage has increased in 2001.

c. The Real Wage didn't change in 2001.

d. We don't have enough information to answer this question.

II. Problems:

1) The island of Yourland is a small closed economy that produces the following goods: cars, butter and jeans. At the end of 2002 and 2003, prices and quantities consumed in the island were:

	2002		2003
	Quantity	Price	Quantity	Price
Cars	10	1500	12	1600
Butter	1000	4	950	4
Jeans	50	20	60	22

Assume that the quantities produced in 2002 are the market basket of goods:

a. Compute the CPI using 2002 as the base year.

b. Compute the CPI using 2003 as the base year.

c. Compute the inflation rate in 2003 in Yourland.

2) Consider the following information about Switzerland:

	Nominal Wage
2002	$ 10.00
2003	$ 11.76

In addition, we know that the inflation rate in Switzerland was 12% in 2003.

a. Compute the CPI (base 2002) for Switzerland.

b. Compute the Real Wage in 2002 dollars for both years.

c. Compute the percentage increase in the Real Wage.

3) Consider the inflation rate in Portugal in the following years:

	Inflation Rate
2000	10%
2001	20%
2002	15%
2003	10%

Complete the table below. All the data has been measured at the end of each year.

	Nominal Wage	CPI (base 1999)	Real Wage
1999	$ 15.00	100
2000	$ 17.60
2001	$ 19.80
2002	$ 20.10
2003	$ 22.21

4) At the end of 2002, Tom wants to buy a used car for $ 1,000 but since he has no money, he asks his brother Bob for a loan. Tom agrees to pay Bob back after 2 years, that is at the end of 2004. Bob doesn't ask for any interest, but he wants to be compensated for the lost in purchasing power due to inflation. The inflation rate is expected to be 5% and 4% in the first and second year of the loan respectively.

a. If the expectations about inflation are correct, what is the amount that Tom will pay to Bob at the end of the loan?

b. Suppose Bob doesn't ask any compensation for the inflation, what is the value of the money he receives at the end of the loan expressed in 2002 dollars?

Suppose that, at the beginning of the loan, Tom agreed to pay $ 92 to Bob as compensation for the lost in purchasing power due to the inflation. Suppose also that the inflation during the second year is unexpectedly 6% instead of the expected 4%.

c. Who looses and who benefits from this unexpectedly higher inflation rate?

d. What is the value of the money that Bob receives at the end of the loan expressed in 2002 dollars?

e. What is the amount that Tom should pay to Bob in order for the purchasing power of the sum lent not to change?