Question

Suppose that the CPI basket of goods consisted of 3 units of pork and 4 units of corn.

year	price of pork	price of corn
2010	$20	$12
2011	$25	$18

1. What is the consumer price index for 2011 if the base year is 2010?
2. What is the inflation rate for 2011?
3. Why might this CPI be biased if used to adjust public pension programs?
4. What is core inflation and what purpose does it serve?

Please explain all your reasoning and show all your work (including mathematical formulas).

Answer 1

a. Cost of the basket of goods in 2010= $20*3 + $12*4 which is equal to 108

Cost of the basket of goods in 2011= $25*3 + $18*4 which is equal to 147

CPI in 2010= $108/$108 * 100 = 100

CPI in 2011= $147/$108 * 100 = 136.11 ( assuming 2010 as base year)

b. Inflation rate for 2011 = (136.11-100) /100 = 36.11%

c. The reason that this CPI will be biased if used to adjust public pension programs is that consumers might substituting the products against rising prices or increasing consumption of new products which might not be reflected in the basket of goods

d. Core CPI measures changes in prices of good and services excluding certain commodities like food items, energy products etc. The purpose is to reduce the volatility in measuring the changes in inflation which are seen in CPI, it is much stable version of measuring inflation rates.