2 Think of an economy consisting of two people Susan and Pie

2) Think of an economy consisting of two people, Susan and Pierre. They only consume books and food: Susan receives meals for free from a foreign admirer, and she only buys 22 books a week for the price of $5 each. Pierre has no time to read, and he buys 21 meals a week for the price of $10 apiece. a) Calculate Susan and Pierre\'s expenditures and their total expenditure. What is the CPI basket of goods? (6 marks)

Solution

a) Susan expenditure = 22 books X $ 5

Susan expenditure = $ 110

Pierre expenditure = 21 meals X $ 10

Pierre expenditure = $ 210

Total expenditure = $ 320

CPI = 100

b) CPI of current year = (Price of basket of goods in current year / Price of basket of goods in base year ) X 100

CPI of current year = (16/15) X 100

CPI of current year = 106.67

CPI inflation rate = (CPI in current year - CPI in base year)/ (CPI in base year ) X 100

CPI inflation rate = (106.67 - 100 / 100 ) X 100

CPI inflation rate = 6.67 %

Susan expenditure = $ 110 ( susan expenditure remains unchanged )

Pierre expenditure = 21 meals X $ 11

Pierre expenditure = $ 231

Increase in expenditure for Pierre = 10%

The CPI inflation rate is 6.67 % , whereas the % increase in total expenditure for Pierre is 10% .

C) If government wishes to compensate consumers for the increase in price as determined by the inflation rate , then Pierre expenditure will be

Pierre expenditure = $ 231 - 0.0667 X $ 231

Pierre expenditure = $ 215.59

Susan expenditure = $ 110 - 0.0667 X 110

Susan expenditure = $ 102.66

Susan will be benefitted more by this compensation because she gets meals free and pays less for the books .