Consider an economy that produces and consumes only three goods, hot dogs, Volle
ID: 1208999 • Letter: C
Question
Consider an economy that produces and consumes only three goods, hot dogs, Volleyballs and shorts. We have the following information on the prices and quantities of these goods in 2014 and in 2015: Assuming that these goods represent all the goods produced and sold in an economy, use the above information to calculate the inflation rate from 2014 to 2015 as measured by a backward looking price index (like the Consumer Price Index or CPI). As part of your answer also discuss any problems that you see with this approach to calculating the inflation rate.Explanation / Answer
Keep the quantity same as the base year 2014.
Total price = 1000 + 1000 + 2000 = 4000
In 2015 it is 2000 + 1500 + 1000 = 4500
Inflation = (4500 - 4000)/4000
i = 12.5%
There is an increase in price of Volleyballs, we cannot outrightly say that the price increase is just an inflation effect. Because there might have been a improvement in the technology or quality which naturally increases the price.