2210 hw06

1 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 = = = 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 M ac 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. 100 2007 i.e. year base in es Expenditur 2008 in es Expenditur  100x $145 $160 A Year of CPI B Year of CPI Amount Dollar A Year Amount Dollar B Year  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 20 1.6 . Putting these values in the formula Multiply both sides by $0.50,  Year B Dollar Amount = = $2 . 2 7 (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 Pri ce Index (CPI) for this year and last year. (a) Based on what you learnt in E CON 2210, calculate your real wages for last year and this year respectively. (4 points) Real wage last year = = = $1,250 Real wage this year = = = $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. 100 year last CPI year last wage Nominal  100 120 $1,500  100 year this CPI year this wage Nominal  100 175 $1,750  44.4 201.6 $0.50 Amount Dollar B Year  50.0$ 44.4 201.6 50.0$ $0.50 Amount Dollar B Year    50.0$ 44.4 201.6  3 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 inve stment 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.