Question

Government survey takers noted the following prices each year for the listed items.

   2016    2017    2018

Pizza $10 $20    $20

Cell Phone Service $90    $180    $180

Crude Oil (barrel)    $90 $180 $90

a. Calculate the percentage increase in PPI from the base year, 2016 to 2017.

b. Calculate the percentage increase in CPI from the base year, 2017 to 2018.

c. What is likely to happen to CPI if the unemployment rate continues to decline.

Answer 1

(a) Producer price index (PPI) includes only crude oil (an input).

% Increase in PPI in 2017 (with 2016 as base year) = ($180/$90) - 1 = 2 - 1 = 1 = 100%

(b) CPI includes pizza and cell phone. Let 1 unit of each be consumed in both years (since exact units is not available).

Cost of basket, 2017 (base year) ($) = 1 x 20 + 1 x 180 = 20 + 180 = 200

Cost of basket, 2018 ($) = 1 x 20 + 1 x 180 = 20 + 180 = 0

Since cost of basket remains unchanged in both years, change in CPI is zero.

(c) When unemployment rate continues to decline, income keeps increasing, signifying that aggregate demand keeps shifting rightward, increasing price level. Therefore cost of the fixed basket keeps increasing, thereby leading to a steady increase in CPI.