2210 hw06

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ASSIGNMENT 6 (20 points)

Note: Please write legibly so that it is easy to read the answers while grading

Last Name _______________________ First Name _________________________

1. Refer to the table above. Consumers in a country buy only two goods, sneakers and

manicures. The prices and quantities purchased by urban households are in the table

above. The reference base year is 2007. Calculate the CPI for 2008. Show your

calculations. (5 points)

Expenditures in 2008 = 2 x $60 + 1 x $40

= $120 + $ 40

= $160

Expenditures in 2007 (base year) = 2 x $55 + 1 x $35

= $110 + $ 35

= $145

CPI for 2008 = 100 2007 i.e.year basein esExpenditur

2008in esExpenditur 

= 100x $145

$160

= 110

(You got partial credit if you had the correct answer but didn’t show calculations.)

2. In 1973, the price of a Big Mac was $0.50. The CPI in 1973 was 44.4 while the CPI in

2006 was 201.6. Calculate the equivalent price of a Big Mac in 2006 dollars. (4 points)

We will use the formula used to compare dollar figures at different dates.

You are trying to find the price of Big Mac in 2006. So the year 2006 is year B and 1973 is

year A.

AYear ofCPI

BYear ofCPI

AmountDollar A Year

AmountDollar BYear 

2

The question tells you Year A dollar amount is $0.50, CPI of Year A (1973) is 44.4 and

CPI of Year B (2006) is 201.6. Putting these values in the formula

Multiply both sides by $0.50,

 Year B Dollar Amount = = $2. 27 (approximately)

Therefore the equivalent price of a Big Mac in 2006 was $2.27.

3. Congratulations! Your boss has given you a raise.

However, you want to know whether your purchasing power has actually increased, since

price level as indicated by the CPI has risen as well. The table below gives you data for

wages and the Consumer Price Index (CPI) for this year and last year.

(a) Based on what you learnt in ECON 2210, calculate your real wages for last year and

this year respectively. (4 points)

Real wage last year = 100 yearlast CPI

yearlast wageNominal 

= 100 120

$1,500 

= $1,250

Real wage this year = 100 year thisCPI

year this wageNominal 

= 100 175

$1,750 

= $1,000

(b) Based on your calculations above, is your purchasing power this year higher or lower

than last year? (1 point)

Since your real wage has decreased this year, your purchasing power is lower this year

than last year.

44.4

201.6

$0.50

AmountDollar BYear 

50.0$ 44.4

201.6 50.0$

$0.50

AmountDollar BYear 

50.0$ 44.4

201.6 

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4. Your bank paid 3% interest on $1,000 deposited in your savings account. The inflation

rate during the year was 4%.

(a) Calculate the real interest rate that you earned on the deposit. (2 points)

The question tells us that the nominal interest rate is 3% and the inflation rate is 4%.

Therefore,

Real interest rate = Nominal interest rate – Inflation rate

= 3% – 4%

= – 1%

(b) Based on your calculations above, did you gain or lose? (1 point)

Since the real interest rate is negative and you are the lender in this case, you lost. This

means that your $1,000 has lost purchasing power due to the 4% inflation but the 3%

interest rate has failed to compensate for the loss in your purchasing power.

5. How does a decrease in income affect saving by households? (1.5 points)

Less income implies less after-tax or disposable income for households which they can now

distribute between consumption and saving.

If income falls then this will reduce both the amount of consumption spending and saving

that households will have.

6. How does an increase in corporate taxes affect investment by firms? (1.5 points)

An increase in corporate taxes will reduce the profit opportunities of firms and hence they

will tend to reduce their investment in the business.