Example: (Checkpoint 7.1. Text p. 171).
A consumer Expenditure Survey in Sparta shows that people buy only juice and cloth. In 2012, the year
of the Consumer Expenditure Survey and also the reference base year, the average household spent $40
on juice and $25 on cloth. Table 1 sets out the prices of juice and cloth in 2012 and 2014.
TABLE 1 PRICES
2012
Juice
$4 a bottle
Cloth
$5 a yard
.
.
2014
$4 a bottle
$6 a yard .
1. Calculate the CPI market basket and the % of household budget spent on juice and the cloth in the
reference base year.
2. Find CPI for 2012 and 2014.
3. Find the inflation rate (π) between 2012 and 2014.
Answer:
1.
Q
Juice 10
Cloth 5
P(2012)
$4
$5
PQ % of budget
$40
61.5%
$25 38.5%
.
.
Q (juice) = PQ/P = $40/$4 = 10
Q (cloth) =PQ/P = $25/$5 = 5
Household budget = ΣPQ = $40 + $25 = $65.
% budget spent on juice = ($40/$65)x100% = 61.5%
% budget spent on cloth = ($25/$65)x100% = 38.5%.
2. Base year 2012
Good Q (2012)
P (2012)
PQ
P’(2014)
P’Q
Juice
10
$4.00
$40
$4.00
$40
Cloth
5
$5.00
$25
$6.00
$30
Cost of CPI basket:
Based period 2012: PQ = $40+$25 = $65.
Current period 2014: P’Q = $40+$30 = $70
Formula: CPI = (cost of CPI basket at current period prices/ cost of CPI basket at
base period prices)x100%
CPI (2012) = ($65/$65) x 100% = 100% = 100
CPI (2014) = ($70/$65) x 100% = 107.7% = 107.7.
3. Inflation rate
π = [(CPI in current year – CPI in previous year)/CPI in previous year]x100%.
π = [(107.7 – 100)/100]x100% = 7.7%.