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suppose a country only buys 2 items, overalls and straw hats. The fixed basket includes 7...

suppose a country only buys 2 items, overalls and straw hats. The fixed basket includes 7 pairs of overalls and 15 straw hats. In 1996, a pair of overalls cost $23.75 and in 2000 they cost $35.99. In 1996 a straw hat cost $3.50 and in 2000 it cost $5.75. What is the inflation between the 2 years? Suppose that the nominal interest rate during this period was 78%, what is the real interest rate?

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Answer #1

Total Cost of basket in the year 1996 = 23.75*7 + 3.5*15 = 166.25 + 52.5 = 218.75

Total Cost of basket in the year 2000 = 35.99*7 + 5.75*15 = 251.93 + 86.25 = 338.18

CPI in the year 1996 = 100(base year)

CPI in the year 2000 = (Cost of basket in current year / Cost of basket in the base year) x 100

=338.18 / 218.75 x 100 = 154.60

Inflation rate = CPI in 2000-CPI in 1996/CPI in 1996x100 = 154.60-100/100x100 =  54.60%

Real interest rate = Nominal interest rate - Inflation rate = 78 - 54.60 = 23.40%

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