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    Essay Test

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    trangnqds170031
    The document contains an essay test with 3 questions about business concepts such as problems with the CPI as a cost of living measure, effects of unexpected inflation on a mortgage, and why the GDP deflator gives a different inflation rate than the CPI. The solutions provide concise explanations of substitution bias and new goods issues with the CPI, how unexpected higher inflation benefited the mortgage borrowers and hurt the bank, and the different scope and methodology of the CPI versus GDP price index.

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    Essay Test

    Uploaded by

    trangnqds170031
    39 views2 pages
    The document contains an essay test with 3 questions about business concepts such as problems with the CPI as a cost of living measure, effects of unexpected inflation on a mortgage, and why the GDP deflator gives a different inflation rate than the CPI. The solutions provide concise explanations of substitution bias and new goods issues with the CPI, how unexpected higher inflation benefited the mortgage borrowers and hurt the bank, and the different scope and methodology of the CPI versus GDP price index.

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    The document contains an essay test with 3 questions about business concepts such as problems with the CPI as a cost of living measure, effects of unexpected inflation on a mortgage, and why the GDP deflator gives a different inflation rate than the CPI. The solutions provide concise explanations of substitution bias and new goods issues with the CPI, how unexpected higher inflation benefited the mortgage borrowers and hurt the bank, and the different scope and methodology of the CPI versus GDP price index.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    39 views2 pages

    Essay Test

    Uploaded by

    trangnqds170031
    The document contains an essay test with 3 questions about business concepts such as problems with the CPI as a cost of living measure, effects of unexpected inflation on a mortgage, and why the GDP deflator gives a different inflation rate than the CPI. The solutions provide concise explanations of substitution bias and new goods issues with the CPI, how unexpected higher inflation benefited the mortgage borrowers and hurt the bank, and the different scope and methodology of the CPI versus GDP price index.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 2

    COURSE NAME: BUSINESS ENVIRONMENT - ECO102

    SEMESTER: FALL 2023

    ESSAY TEST

    Class: HM17D
    Name: Nguyen Quynh Trang
    Student ID: DS170031
    Lecturer: Duong Nguyen Minh Huy

    Task:
    1. List the three major problems in using the CPI as a measure of the cost of living.
    2. Jay and Joyce meet George, the banker, to work out the details of a mortgage. They
    all expect that inflation will be 2 percent over the term of the loan, and they agree on a
    nominal interest rate of 6 percent. As it turns out, the inflation rate is 5 percent over
    the term of the loan.
    a. What was the expected real interest rate?
    b. What was the actual real interest rate?
    c. Who benefited and who lost because of the unexpected inflation?
    3. Why does the GDP deflator give a different rate of inflation than the CPI?

    Solution:

    1.
    The three major problems with using the CPI as a measure of the cost of living:
    - Substitution bias:
    + Over time, some prices rise faster than others
    + Consumers substitute toward goods that become relatively cheaper, mitigating
    the effects of price increases.
    + The CPI misses this substitution because it uses a fixed basket of goods.
    + Thus, the CPI overstates increases in the cost of living.
    - Introduction of New Goods:
    + The introduction of new goods increases variety, allows consumers to find
    products that more closely meet their needs.
    + In effect, dollars become more valuable.
    + The CPI misses this effect because it uses a fixed basket of goods.
    + Thus, the CPI overstates increases in the cost of living.
    - Geographical Differences:
    + The CPI is a national average, so it doesn't consider regional variations in
    living costs.
    + Costs of living can differ significantly between cities and rural areas, making
    the CPI less accurate for some individuals or regions.

    2.
    a.
    Expected real interest rate = Nominal interest rate - Expected inflation = 6% - 2% =
    4%
    So, the expected real interest rate is 4%
    b.
    Actual real interest rate = Nominal interest rate - Actual inflation = 6% - 5% = 1 %
    So, the actual real interest rate is 1%
    c.
    Jay and Joyce benefitted from the unexpected inflation because they paid back the
    loan with inflated dollars - their real interest rate on the mortgage was only 1% when
    they expected to pay 4%. George and the bank lost because they didn't make as much
    as expected on the loan - they expected to earn 4% and only earned 1%.

    3.
    The GDP deflator gives a different inflation rate than the CPI because these two
    indexes measure inflation using two different methods.
    - The CPI measures price changes in goods and services purchased out of pocket
    by urban consumers. It includes anything bought by consumers including
    foreign goods.
    - Whereas, the GDP price index and implicit price deflator measure price
    changes in goods and services purchased by consumers, businesses,
    government, and foreigners, but not importers. It includes only domestic goods
    and not anything that is imported.
    Therefore, when there is a difference between these two indexes, it can be due to
    uneven production and income growth in the economy, as well as the impact of other
    factors such as fluctuations in energy prices and food.

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