Consider Table 15.1 but 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 consumer price indexes? Explain. Generalize your answer to explain how the construction of the market basket affects the CPI.
Pre-frost, this market basket costs (100 × $0.20) + (50 × $0.60) + (200 × $0.25) = $20 + $30 + $50 = $100. The same market basket, post-frost, costs (100 × $0.40) + (50 × $1.00) + (200 × $0.45) = $40 + $50 + $90 = $180. Thus, the price index is ($100/$100) × 100 = 100 before the frost and ($180/$100) × 100 = 180 after the frost, implying a rise in the price index of 80%. This increase in the price index is less than the 84.2% increase calculated in the text. The reason for this difference is that the new market basket of 100 oranges, 50 grapefruit, and 200 lemons contains proportionately more of an item that has experienced a relatively small price increase (the lemons, the price of which has increased by 80%) and proportionately fewer of an item that has experienced a relatively large price increase (the oranges, the price of which has increased by 100%). This shows that the price index can be very sensitive to the composition of the market basket. If the market basket contains a large proportion of goods whose prices have risen faster than the prices of other goods, it will lead to a higher estimate of the increase in the price level. If it contains a large proportion of goods whose prices have risen more slowly than the prices of other goods, it will lead to a lower estimate of the increase in the price level.
Question
For each of the following events, explain how the use of a 10-year-old market basket would bias measurements of price changes over the past decade.
A typical family owns more cars than it would have a decade ago. Over that time, the average price of a car has increased more than the average prices of other goods.
A market basket determined 10 years ago will contain fewer cars than at present. Given that the average price of a car has grown faster than the average prices of other goods, this basket will underestimate the true increase in the price level because it contains relatively too few cars.
Virtually no households had tablet PCs a decade ago. Now many households have them, and their prices have been falling.
A market basket determined 10 years ago will not contain tablet PCs, so it cannot track the fall in prices of tablet PCs over the past few years. As a result, it will overestimate the true increase in the price level.
Question
The consumer price index in the United States (base period 1982–1984) was 214.537 in 2009 and 218.056 in 2010. Calculate the inflation rate from 2009 to 2010.
Using Equation 15-2, we determine that the infl ation rate from 2009 to 2010 is (218.056 - 214.537)/214.537 × 100 = 1.640%.