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Econ 645

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Assume that a typical consumer basket includes 50 bars of each type. Compute a consumer price index for each year and determine the percentage change in the index over the two years.
Last year, Jimmy’s consumer basket was $100 worth of Snicker’s bars, and $50 worth of Butterfinger bars for a total consumer basket of $150.
This year, Jimmy’s consumer basket is $75 worth of Snicker’s bars, and $87.50 worth of Butterfinger bars for a total consumer basket of $162.50.
The percentage change in the index over the two years is as follows:
(162.50/150) – 1.0 x 100 = .083 or 8.3%
Calculate Jimmy's nominal spending on candy bars in each year. Does nominal spending increase or decrease?
Nominal spending is the total value of output produced in each year. Last year, Jimmy spent $150 on Snickers (75 x $2) and $100 on Butterfinger bars (100 x $1) for a total of $250.
This year Jimmy spent $180 on Snickers (120 x $1.50) and $157.50 on Butterfinger bars (90 x $1.75) for a total of $337.50.
Jimmy’s nominal spending increased this year.
Using the first year as the base year, determine Jimmy's real spending on candy bars in each year. Does real spending increase or decrease?
Real spending is the total value of output produced in each year valued at the prices prevailing in year one. Last year, Jimmy’s real spending is the same as his nominal spending - $250.
This year, Jimmy’s real spending on Snickers is $240 (120 x $2) and $90 (90 x $1.00) on Butterfinger bars for a total of $330.
Jimmy’s real spending increased this year.
Calculate the implicit price deflator (defined as nominal spending divided by real spending). How does this deflator compare the CPI calculated in part (a)? Which measurement do you think is more relevant in determining the change in Jimmy's cost of living?
The implicit price deflator is as follows: 337.50/330 = 1.02.
Implicit price deflator is more relevant in determining the change in Jimmy’s cost of living because the CPI will not measure the change in cost of living of every consumer because of the differences in consumption patterns.

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