Chapter 15, Problem 2FRQ

a)

To determine

The question requires us to define the CPI.

Explanation of Solution

CPI measures the change in prices of a basket of goods and services in a given time. It is used to calculate the official inflation rate in an economy. The following expression shows the relationship between CPI and the inflation rate.

  $\text{Inflation}\text{}\text{rate = }\frac{\text{CPI}\text{in}\text{year}\text{2 - CPI}\text{in}\text{year}\text{1}}{\text{CPI in year}\text{1}}\text{×100}$

Generally, government payments and private payments such as tax brackets, cost-of-living allowances, and wage settlements are indexed to the CPI.

b)

To determine

The question requires us to determine the value of the inflation rate.

Answer to Problem 2FRQ

The inflation rate between year 1 and year 2 is 1.48 percent.

Explanation of Solution

From part 1,

Price index in year 1 = 229.6

Price index in year 2 = 233

Insert these values in the inflation formula:

  $\begin{array}{c}\text{Inflation}\text{}\text{rate = }\frac{\text{Price}\text{index}\text{in}\text{year}\text{2 - Price}\text{index}\text{in}\text{year}\text{1}}{\text{Price}\text{index}\text{in}\text{year}\text{1}}\text{×100}\\ =\frac{233-229.6}{229.6}\times 100\\ =1.48\end{array}$

The inflation rate between year 1 and year 2 is 1.48 percent.

Economics Concept Introduction

The inflation rate formula in terms of price index is:

  $\text{Inflation}\text{}\text{rate = }\frac{\text{Price}\text{index}\text{in}\text{year}\text{2 - Price}\text{index}\text{in}\text{year}\text{1}}{\text{Price}\text{index}\text{in}\text{year}\text{1}}\text{×100}$