Critical Thinking Questions

21 . Name several forms of indexing in the private and public sector.

Critical Thinking Questions

22 . Inflation rates, like most statistics, are imperfect measures. Can you identify some ways that the inflation rate for fruit does not perfectly capture the rising price of fruit? 23 . Given the federal budget deficit in recent years, some economists have argued that by adjusting Social Security payments for inflation using the CPI, Social Security is overpaying recipients. What is their argument, and do you agree or disagree with it? 24 . Why is the GDP deflator not an accurate measure of inflation as it impacts a household? 25 . Imagine that the government statisticians who calculate the inflation rate have been updating the basic basket of goods once every 10 years, but now they decide to update it every five years. How will this change affect the amount of substitution bias and quality/new goods bias? 26 . Describe a situation, either a government policy situation, an economic problem, or a private sector situation, where using the CPI to convert from nominal to real would be more appropriate than using the GDP deflator. 27 . Describe a situation, either a government policy situation, an economic problem, or a private sector situation, where using the GDP deflator to convert from nominal to real would be more appropriate than using the CPI. 28 . Why do you think the U.S. experience with inflation over the last 50 years has been so much milder than in many other countries? 29 . If, over time, wages and salaries on average rise at least as fast as inflation, why do people worry about how inflation affects incomes? 30 . Who in an economy is the big winner from inflation? 31 . If a government gains from unexpected inflation when it borrows, why would it choose to offer indexed bonds? 32 . Do you think perfect indexing is possible? Why or why not?

Problems

33 . The index number representing the price level changes from 110 to 115 in one year, and then from 115 to 120 the next year. Since the index number increases by five each year, is five the inflation rate each year? Is the inflation rate the same each year? Explain your answer. 34 . The total price of purchasing a basket of goods in the United Kingdom over four years is: year 1=£940, year 2=£970, year 3=£1000, and year 4=£1070. Calculate two price indices, one using year 1 as the base year (set equal to 100) and the other using year 4 as the base year (set equal to 100). Then, calculate the inflation rate based on the first price index. If you had used the other price index, would you get a different inflation rate? If you are unsure, do the calculation and find out. 35 . Within 1 or 2 percentage points, what has the U.S. inflation rate been during the last 20 years? Draw a graph to show the data. 36 . If inflation rises unexpectedly by 5%, indicate for each of the following whether the economic actor is helped, hurt, or unaffected: a. A union member with a COLA wage contract b. Someone with a large stash of cash in a safe deposit box c. A bank lending money at a fixed rate of interest