14. Which of the following is correct?

a. The CPI is not based on a fixed basket of goods and services.

b. The GDP deflator reflects the prices of all domestically produced goods and services.

c. The GDP deflator is based on a fixed basket of goods and services.

d. The GDP deflator is subject to substitution bias.

ANSWER: B

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15. The inflation rate

a. is a measure of the cost of a basket of goods and services bought by firms

b. is the absolute change in prices between years

c. is the percentage change in the price index from the preceding period

d. measures changes in incomes from one year to the next

ANSWER: C

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Short Answer

1. What is the consumer price index (CPI)? What are the three major items included in the CPI?

RESPONSE:

ANSWER: The CPI is a measure of the overall cost of the goods and services bought by a typical consumer. The three major items included in the CPI are shelter, transportation and food.

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2. How is the CPI computed?

RESPONSE:

ANSWER: First the basket of goods and services must be determined and also the relative importance of the various items to be included in the basket. Then the prices of the various items in the basket are determined. The cost of the basket is then determined using the data on prices and quantity. The base year is chosen, and the index for the base year is computed using the quantities in the basket and the base year prices. The index is calculated by taking the price of the basket in the each year and dividing this by the price of the basket in the base year. This ratio is then multiplied by 100.

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