ECON 200 Chapter 21

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All prices rise evenly during periods of inflation and deflation.


Apply the correct label to each inflation-related problem. Labels may be used more than once.

The normal rate of inflation is about 3%. Hector notices the cost of a movie increases by 3% and decides not to go because he mistakenly concludes that movies have become more expensive. (money illusion) Because of extremely high inflation, David makes small weekly cash withdrawals instead of large monthly ones. (shoe-leather costs) Selena decides to move to a city with a very high cost of living, for a job with a slightly higher salary. (money illusion) Inflation forces a car dealership to increase its prices and pay for frequent ads in the newspaper to announce the changes. (menu costs)

Click on the part of the graph that best illustrates the upward bias of traditional CPI.

after 2012

Click on the year on the timeline when the U.S. Consumer Price Index dropped significantly from the year before.

between 2005-2015

Gwyn owns a furniture store. She notices prices at other furniture stores have increased dramatically over the past two years. She decides she needs to expand her output because demand must be growing. However, in order to do so, she needs to find a loan. What problems could inflation cause for Gwyn?

Gwyn might misinterpret rising prices associated with inflation for a higher demand. Gwyn may need to spend money to update her price displays throughout the store. Lenders may be wary of providing Gwyn a loan because it is difficult to predict future price levels.

If, in a given year, the money supply changes by +2%, the price level changes by +3.5%, and GPD changes by -1%, what is the change in the velocity of money?


Inflation occurs when the overall prices of goods [blank]. This means that consumers have [blank] purchasing power. Deflation occurs when the overall prices of goods [blank]. When this happens, consumers have [blank] purchasing power.

increase; less; decrease; more;

Last year you paid $24 for a round of golf and $12 to rent a golf cart. This year it cost you $30 to golf and $15 to rent a cart. Based on this simple basket of goods, calculate a price index for this year using last year as the base year.


Mary’s costs will rise, and for revenue to keep pace she will have to [blank] to keep her prices consistent with inflation. If Mary mistakenly believes the rising price of seafood is the result of increased [blank], she may misdirect restaurant resources. This would be an example of price [blank].

deal with menu costs; demand; confusion;

Match the situation to the factor that affects the accuracy of the CPI.

New pop-up stores at airports sell clothing, personal electronics, and designer eyewear at low prices. (new locations) The cost of bananas increases dramatically. Many people switch to oranges because they are cheaper. (substitution) The cost of cable increases. People decide to switch to Netflix instead. (substitution) A new smartphone app solves math problems simply by pointing the camera at the page. (new products) Newer cars have built-in GPS and Bluetooth capabilities. (changes in quality) Video game consoles offer better graphics and gameplay than they did a decade ago. (changes in quality)

Match the situation to the inflation-related problem it illustrates.

A surprise increase in inflation devalues borrowers’ future payments to lenders. (wealth redistribution) Producers are unable to determine how much output to produce. (price confusion) Unstable inflation makes it difficult for lenders to anticipate the value of their money in the future. (uncertainty about future price levels)

Max lives in Boston and earns $132,500 per year. If Max decides to move to San Francisco, what annual salary will he need to make in order to maintain the same real wage?


Place the correct price in each blank, to reflect the effects of inflation. Use 230 as the price index for the current year.

$0.82; $0.96; $0.61;

Suppose the consumer price index for one year was 120 and for the next year it was 132. What is the corresponding inflation rate?


Suppose the current CPI is 240 and in 2002 it was 180. A pair of Levi’s jeans costs $54 today. Based on the CPIs, what would you expect the 2002 price to have been for the same style of Levis, in a similar retail outlet?


Suppose the inflation rate is 2% per year. If you currently think of $40,000 as an acceptable retirement income and are expecting to retire in 40 years, what will the equivalent annual income then be, adjusted for inflation? Round your answer to the nearest dollar.


Suppose you’re working in your hometown. You have an opportunity to take a new job in a different city, where the cost of living is different.
In each of the following situations, would your real wage be higher or lower in the new job?

The cost of living in the new city is 3% lower, and you’d be paid the same amount. The cost of living in the new city is 10% lower, and you’d take a 5% pay cut. The cost of living in the new city is 8% higher, and you’d get a raise of 10%.

Surprise inflation can help people who have borrowed money.


Take 2014 as the price index base year. That year, you paid $80 for a day at a theme park. In 2015, the price was up to $84. Assuming that the increase reflects the inflation rate and that this rate continues in 2016, match each number to its description.

the cost of a theme park visit in 2016 dollars (88.20) the 2015 price index (105) the inflation rate as a percentage (5) the 2016 price index (110.25)

The chained CPI is [blank] than the traditional CPI. The chained CPI is updated [blank] in an effort to compensate for the [blank] of new products. The traditional CPI has a strong [blank] bias.

more accurate; monthly; price changes; upward;

The Consumer Price Index (CPI) and the GDP deflator are both price indices, so they both serve as measures of inflation. However, the [blank] uses a smaller basket of goods. The [blank] aims to take into account all final goods and services, whereas the [blank] only includes goods and services sold to [blank]. So, for instance, prices on farm equipment are included in the [blank] but not in the [blank].

CPI; GDP deflator; CPI; consumers; GDP deflator; CPI;

The graphic shows the timeline of production, beginning with preparations and ending with the output being sold to customers.
Suppose there is uncertainty about the amount of inflation that will occur during the "Produce" period, between the signing of contracts and the collection of sales revenue. Label each item as being based, ultimately, on a worry that inflation will be higher than expected or that it will be lower than expected.

The workers worry they agreed to lower wages than they should have. The lender worries that the loan rate is too low.

The velocity of money is the frequency with which money [blank]. The greater the money velocity, the [blank] goods and services are being traded. By the equation of exchange, the money velocity times [blank] equals the price level times [blank].

changes hands; more; the size of the money supply; real GDP;

Thirty years ago Daniel bought a plot of land for $50,000 when the CPI was 50. Now the CPI is 180 and he sold the land for $180,000. What issue might inflation cause for Daniel?

tax distortions

Two things tempt governments to enact inflationary policies. The first is [blank], which can be paid off by [blank]. The second is [blank] economy, which in the short term can be jump-started by a [blank] increase in the money supply.

government debt; printing money; a sluggish; surprise;

What are the three reasons why the CPI is hard to measure accurately?

new products to buy and new ways for consumers to buy them consumers substituting one good for another because of price changes in the quality of the same good, over time

What best describes why inflation occurs?

increased money supply, relative to the supply of goods and services.

What could happen if the CPI were under-calculated?

Wages will be too low.

What is the main advantage of the Billion Prices Project over the CPI?

Many prices can be monitored daily.

Which of the following may be considered as part of the consumer price index?

food housing transportation

Which of the following problems can inflation cause for suppliers?

Prices begin to rise, so firms increase output. Long-term agreements become too risky for lenders, making it more difficult to obtain a loan.

Which of the following scenarios make it difficult to accurately measure the CPI?

The price of a ticket to a baseball game increases after the stadium is rebuilt. A company releases a new product that many consumers adopt.

Why might the prices of some products decrease while others increase?

Advances in technology typically cause the price of some goods to decrease over time.

You live in Atlanta and earn $95,600 a year. Your boss offers you a $10,000 raise and the opportunity to move to another city and work remotely. If maintaining at least the same real wage is your only concern, select all the cities to which you could relocate.

Richmond, VA-104.5; Phoenix, AZ-100.7; Detroit, MI-99.4; Charlotte, NC-93.2; Dallas, TX-91.9;

Your parents bought their first car for $5,000. The price level in the year your parents bought their car was 50, while the price level today is 200. Calculate how much your parents’ car would have cost if they bought it today.


You live in Atlanta and earn $95,600 a year. Your boss offers you a $10,000 raise and the opportunity to move to another city and work remotely. If maintaining at least the same real wage is your only concern, select all the cities to which you could relocate.

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