Term
True or False? As of December 2010, housing, transportation, and medical care were the largest three categories of expenditures in the CPI's market basket. 

Definition
FALSE. As of December 2010, housing, transportation, and food and beverages were the largest three categories of expenditures in the CPI's market basket. 


Term
True or False? If the CPI is 230, then the average price of the goods and services purchased by the typical urban family of four is 230 percent higher than the average price in the base year. 

Definition
FALSE. If the CPI is 230, then the average price of the goods and services purchased by the typical urban family of four is 130 percent higher than the average price in the base year. 


Term
The market basket for Wrexington's CPI consists of 3 collars and 2 leashes. The base year is 2007. In 2006, the price of a collar was $1 and the price of a leash was $5. In 2007, the price of a collar was $2 and the price of a leash was $5. In 2008, the price of a collar was $2 and the price of a leash was $7. In 2009, the price of a collar was $2 and the price of a leash was $9. In 2010, the price of a collar was $4 and the price of a leash was $10. What was the cost of Wrexington's CPI market basket in 2006? 

Definition
13 cost of basket in 2006 = ($1)(3) + ($5)(2) = $13 


Term
The market basket for Wrexington's CPI consists of 3 collars and 2 leashes. The base year is 2007. In 2006, the price of a collar was $1 and the price of a leash was $5. In 2007, the price of a collar was $2 and the price of a leash was $5. In 2008, the price of a collar was $2 and the price of a leash was $7. In 2009, the price of a collar was $2 and the price of a leash was $9. In 2010, the price of a collar was $4 and the price of a leash was $10. What was Wrexington's CPI in 2008? 

Definition
125 cost of basket in 2007 = ($2)(3) + ($5)(2) = $16 cost of basket in 2008 = ($2)(3) + ($7)(2) = $20 CPI in 2008 = ($20/$16)(100) = 125 


Term
The market basket for Wrexington's CPI consists of 3 collars and 2 leashes. The base year is 2007. In 2006, the price of a collar was $1 and the price of a leash was $5. In 2007, the price of a collar was $2 and the price of a leash was $5. In 2008, the price of a collar was $2 and the price of a leash was $7. In 2009, the price of a collar was $2 and the price of a leash was $9. In 2010, the price of a collar was $4 and the price of a leash was $10. What was Wrexington's inflation rate from 2009 to 2010? 

Definition
33 cost of basket in 2007 = ($2)(3) + ($5)(2) = $16 cost of basket in 2009 = ($2)(3) + ($9)(2) = $24 cost of basket in 2010 = ($4)(3) + ($10)(2) = $32 CPI in 2009 = ($24/$16)(100) = 150 CPI in 2010 = ($32/$16)(100) = 200 inflation rate from 2009 to 2010 = [(200150)/150][100%] = (50/150)(100%) = 33% 


Term
True or False? When an economy is experiencing inflation, the prices of all goods and services in the economy are increasing. 

Definition
FALSE. At any point, some prices are increasing and some are decreasing. Inflation means that the price increases outweigh the price decreases. 


Term
True or False? Over the past 60 years, the price level has risen an average of about 2% per year in the U.S. 

Definition
FALSE. Over the past 60 years, the price level has risen an average of about 4% per year in the U.S. 


Term
True or False? The U.S. economy has not experienced deflation since the 1950s. 

Definition
FALSE. The U.S. economy experienced deflation in January 2009. 


Term
True or False? Substitution bias, increase in quality bias, new product bias, and outlet bias all cause changes in the CPI to understate the true inflation rate. 

Definition
FALSE. Substitution bias, increase in quality bias, new product bias, and outlet bias all cause changes in the CPI to overstate the true inflation rate. 


Term
True or False? Holding all else constant, when the price of domestically produced industrial robots increases, both the GDP deflator and the CPI increase. 

Definition
FALSE. Industrial robots are not purchased by the typical urban family of four, so their price is not included in the CPI. Therefore, the GDP deflator increases, but the CPI stays the same. 


Term
True or False? The CPI tends to increase after the PPI increases. 

Definition


Term
In Iowa, the price of a paperback novel was $1 in 1950 and $7 in 2010. Iowa's CPI was 30 in 1950 and 150 in 2010. What is the 1950 price of a paperback novel in 2010 dollars? 

Definition
5 1950 price of paperback novel in 2010 dollars = ($1)(150/30) = $5 


Term
Esme is offered a job in Chicago at a salary of $80,000 per year. She is also offered a job in Tucson at a salary of $70,000 per year. The CPI for Chicago is 230, and the CPI for Tucson is 200. If Esme only cares about maximizing her purchasing power, which job should she take? 1. Chicago 2. Tucson 

Definition
2. Tucson Chicago salary in Chicago dollars = $80,000 Tucson salary in Chicago dollars = ($70,000)(230/200) = $80,500 OR Chicago salary in Tucson dollars = ($80,000)(200/230) = $69,565 Tucson salary in Tucson dollars = $70,000 


Term
True or False? If the nominal interest rate is 7% per year and the inflation rate is 2% per year, then the number of dollars in a savings account will increase by 5% per year. 

Definition
FALSE. If the nominal interest rate is 7% per year and the inflation rate is 2% per year, then the number of dollars in a savings account will increase by 7% per year (nominal interest rate) and the purchasing power of the savings account will increase by 5% per year (real interest rate). 


Term
True or False? If the nominal interest rate is 1% per year and the inflation rate is 2% per year, then the real interest rate is 1% per year. 

Definition
FALSE. If the nominal interest rate is 1% per year and the inflation rate is 2% per year, then the real interest rate is 3% per year [1%  (2%) = 1% + 2% = 3%]. 


Term
True or False? The real interest rate is more important to borrowers and lenders than the nominal interest rate is. 

Definition


Term
True or False? For the average consumer, purchasing power is not affected by inflation in the long run. 

Definition


Term
People on fixed incomes prefer inflation to be lower than expected. 

Definition
TRUE. When the inflation rate is lower than expected, the purchasing power of a fixed income is higher than expected. 


Term
If the real interest rate is 3%, the inflation rate is 2%, and nominal interest is taxed at 20%, then what is the aftertax real interest rate? 

Definition
2 nominal interest rate = real interest rate + inflation rate = 3% + 2% = 5% 20% tax on nominal interest = (nominal interest rate)(0.2) = (5%)(0.2) = 1% aftertax real interest rate = real interest rate  tax = 3%  1% = 2% 


Term
True or False? People with savings accounts prefer inflation to be lower than expected. 

Definition
TRUE. When the inflation rate is lower than expected, the real interest rate is higher than expected, so the purchasing power of a savings account increases faster than expected. 


Term
True or False? A government that sold bonds prefers inflation to be lower than expected. 

Definition
FALSE. When the inflation rate is lower than expected, the real interest rate is higher than expected, so the government is paying interest on the bonds with dollars that have higher purchasing power than expected (i.e., the government is giving up more purchasing power than it expected). 


Term
True or False? Banks that made longterm fixed rate loans prefer inflation to be lower than expected. 

Definition
TRUE. When the inflation rate is lower than expected, the real interest rate is higher than expected, so the dollars the bank receives from interest payments on the loans have more purchasing power than expected (i.e., the bank is earning more purchasing power than it expected). 

