Economics
2024 Release By
Dean Karlan Jonathan
Morduch (Solutions
Manual All Chapters 100%
Original Verified, A+
Grade)
Part 1: Chapter 25-36
Part 2: Chapter 11-24
Part 3: 1-10
All Chapter Arranged Reverse
,Chapter 25 - The Cost of Living
Part 1: Chapter 25-36 CHAPTER 25
THE COST OF LIVING
Solutions to End-of-Chapter Questions and Problems
Review Questions
1. If we want to measure changes in the cost of living, why don’t we track difference in each
household’s actual expenditures from one year to the next, rather than the difference in the
cost of a market basket? Offer several reasons why this method would fail to capture changes
in the overall price level accurately. [LO 25.1]
Answer: We don’t track changes in actual expenditures from year to year because we want
to be sure we are measuring changes in prices and not changes in quantities. Households
change the types and amounts of goods and services they buy for several reasons. First, as
certain goods become more expensive, consumers may substitute away to different goods
whose prices have not increased as rapidly. Furthermore, people’s consumption patterns may
change due to tastes or changes in income that have nothing to do with changing prices.
Finally, innovation can lead to the introduction of new products or improvements in existing
products. Changes in spending on these goods are difficult to attribute to simple changes in
price.
2. There are many different types of market baskets that economists measure. For example, the
market basket for consumers—called the Consumer Price Index—tracks the prices associated
with the typical consumer’s purchases of goods and services. The Producer Price Index
tracks the prices of the goods and services purchased by firms. A third type of market basket
is the Home Price Index, which tracks the value of residential housing. In what scenarios
would each of these market baskets be useful? [LO 25.1]
Answer: Measuring the cost of living for a typical consumer is probably best addressed
through a broad-based index like the CPI. Besides being helpful in examining price changes
that might affect businesses, the PPI is also useful as a gauge of future CPI inflation since
businesses typically pass on some of their increases in input costs to consumers. A Home
Price Index is useful for measuring differences in the cost of living between different cities. It
is well known that some cities like New York City and San Francisco are more costly to live
in than other regions of the country, but it is difficult to easily and accurately measure every
price difference between cities. By measuring the difference in housing prices, which are a
large portion of a typical household's budget and are also the budget item that varies most
widely from city to city, differences in the overall cost of living can be approximated.
25-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
,Chapter 25 - The Cost of Living
3. Why is the list of the highest-grossing films of all time dominated by movies made within the
last 10 years? (Hint: Did Avatar: The Way of Water, released in 2022, really sell considerably
more movie tickets than the classic Gone with the Wind, or is something else going on?) [LO
25.2]
Answer: Given the price of tickets has risen over time, studios can make more money, in
nominal terms, selling tickets now than in the past. It’s a lot easier to sell $100 million worth
of tickets when tickets are $15 each than when they are only 25 cents apiece. A second
reason, although not related to the topic of prices, is that the population has grown over time.
In 1939, the year Gone with the Wind was released, the U.S. population was only about 131
million; in contrast, the U.S. population in 2022 was about 333 million. That’s 202 million
additional ticket buyers now as opposed to 83 years ago.
4. How would you use the concept of the Consumer Price Index to compare prices across
different locations? [LO 25.2]
Answer: You could use the concept of the CPI to compare prices across locations by
creating a basket with the same goods in two different places and then measuring how the
prices changed in each basket over a set period of time. For example, if you wanted to
compare the prices in Iowa City and Kansas City, you would compare the prices of the same
goods in both cities over time.
5. What types of goods and services would a basket measuring the inflation rate for farmers
include? Why doesn’t the BLS calculate the price levels for a market basket approximating
the purchases of farmers? [LO 25.3]
Answer: A basket for farmers might include many of the goods we normally buy—bread or
jeans, for example—but it might include fewer eggs or vegetables than the basket for the
average urban consumer. (Farmers would be able to raise or grow these things themselves.)
The market basket probably also would include fertilizers and seeds to grow crops. The BLS
does not measure price increases for farmers because less than 1 percent of the current
American population are farmers. It would be a lot of work and effort to explicitly measure
the price level for such a small segment of the population.
6. Does the CPI represent the actual change in the cost of living for any given household?
Explain why or why not. [LO 25.3]
Answer: No. The CPI measures the cost living for an average (urban) household. Every
household consumes slightly different types of goods, which may be more or less expensive
than another household’s consumption basket. The CPI measures the cost of living for a
typical household, but individual households may experience inflation that is higher or lower
than that measured by the change in the CPI.
25-2
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, Chapter 25 - The Cost of Living
7. Suppose wages rise in China, leading to an increase in the price of toys imported from China.
How would this change affect the CPI, PPI, and the GDP deflator in the United States? [LO
25.4]
Answer: In the United States, imported Chinese toys are part of the CPI (since Chinese toys
are part of the basket of goods and services an average household might consume) but are not
part of the GDP deflator (since Chinese toys are not part of the U.S. GDP). Typically, toys are
not used as inputs for producers, so they would not be part of the PPI either. Thus, the U.S.
CPI would rise, but the PPI and GDP deflator would be unchanged. In China, if all of these
toys are exported, the CPI (and PPI) would not change, but the GDP deflator would rise. Of
course, an increase in wages would likely affect other industries outside of exporting sectors,
leading to increases in the CPI and PPI of China as well.
8. If the growth rate in nominal income is larger than the inflation rate (as measured by the
change in the CPI or the GDP deflator), has the real value of income grown? [LO 25.4]
Answer: Any time a nominal value is rising faster than the inflation rate, the real value will
be rising. The intuition is that real income is rising by the rate of nominal income growth but
falling by the rate of inflation. As long as nominal income growth outpaces inflation, real
incomes will be rising. To convince yourself of this, try a simple numerical example. Think
back to the equation earlier in the chapter for the value of 1969 income in 2021 dollars:
1969real2021 = 1969nominal × (CPI2021/CPI1969)
To make the calculations easier, suppose 1969nominal = 10,000 and CPI1969 = 100. Now
suppose 2021nominal rises by 10% over 1969nominal and CPI2021 rises 5% over CPI2021:
2021nominal = 11,000 (10% higher than 1969), and CPI2021 = 105 (5% higher than 1969)
Now calculate 1969real and see whether it is higher or lower than 2021real:
2021real = 2021nominal = 11,000
1969real = 10,000 × (105/100) = 10,500
So, real income has risen between 1969 and 2021. You can try this with any combination of
numbers. As long as nominal income is rising faster than the CPI, 2021real will be greater than
1969real.
9. What is the better measure of inflation to determine how much should be paid to employees
for cost-of-living adjustments: the Producer Price Index (PPI) or the CPI? Why? [LO 25.5]
Answer: Remember that the typical employee, when he or she leaves work, becomes a
typical consumer. Thus, an employee’s cost of living is closely approximated by the CPI, and
therefore employee’s wages should be adjusted by the CPI, not the PPI.
25-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
2024 Release By
Dean Karlan Jonathan
Morduch (Solutions
Manual All Chapters 100%
Original Verified, A+
Grade)
Part 1: Chapter 25-36
Part 2: Chapter 11-24
Part 3: 1-10
All Chapter Arranged Reverse
,Chapter 25 - The Cost of Living
Part 1: Chapter 25-36 CHAPTER 25
THE COST OF LIVING
Solutions to End-of-Chapter Questions and Problems
Review Questions
1. If we want to measure changes in the cost of living, why don’t we track difference in each
household’s actual expenditures from one year to the next, rather than the difference in the
cost of a market basket? Offer several reasons why this method would fail to capture changes
in the overall price level accurately. [LO 25.1]
Answer: We don’t track changes in actual expenditures from year to year because we want
to be sure we are measuring changes in prices and not changes in quantities. Households
change the types and amounts of goods and services they buy for several reasons. First, as
certain goods become more expensive, consumers may substitute away to different goods
whose prices have not increased as rapidly. Furthermore, people’s consumption patterns may
change due to tastes or changes in income that have nothing to do with changing prices.
Finally, innovation can lead to the introduction of new products or improvements in existing
products. Changes in spending on these goods are difficult to attribute to simple changes in
price.
2. There are many different types of market baskets that economists measure. For example, the
market basket for consumers—called the Consumer Price Index—tracks the prices associated
with the typical consumer’s purchases of goods and services. The Producer Price Index
tracks the prices of the goods and services purchased by firms. A third type of market basket
is the Home Price Index, which tracks the value of residential housing. In what scenarios
would each of these market baskets be useful? [LO 25.1]
Answer: Measuring the cost of living for a typical consumer is probably best addressed
through a broad-based index like the CPI. Besides being helpful in examining price changes
that might affect businesses, the PPI is also useful as a gauge of future CPI inflation since
businesses typically pass on some of their increases in input costs to consumers. A Home
Price Index is useful for measuring differences in the cost of living between different cities. It
is well known that some cities like New York City and San Francisco are more costly to live
in than other regions of the country, but it is difficult to easily and accurately measure every
price difference between cities. By measuring the difference in housing prices, which are a
large portion of a typical household's budget and are also the budget item that varies most
widely from city to city, differences in the overall cost of living can be approximated.
25-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
,Chapter 25 - The Cost of Living
3. Why is the list of the highest-grossing films of all time dominated by movies made within the
last 10 years? (Hint: Did Avatar: The Way of Water, released in 2022, really sell considerably
more movie tickets than the classic Gone with the Wind, or is something else going on?) [LO
25.2]
Answer: Given the price of tickets has risen over time, studios can make more money, in
nominal terms, selling tickets now than in the past. It’s a lot easier to sell $100 million worth
of tickets when tickets are $15 each than when they are only 25 cents apiece. A second
reason, although not related to the topic of prices, is that the population has grown over time.
In 1939, the year Gone with the Wind was released, the U.S. population was only about 131
million; in contrast, the U.S. population in 2022 was about 333 million. That’s 202 million
additional ticket buyers now as opposed to 83 years ago.
4. How would you use the concept of the Consumer Price Index to compare prices across
different locations? [LO 25.2]
Answer: You could use the concept of the CPI to compare prices across locations by
creating a basket with the same goods in two different places and then measuring how the
prices changed in each basket over a set period of time. For example, if you wanted to
compare the prices in Iowa City and Kansas City, you would compare the prices of the same
goods in both cities over time.
5. What types of goods and services would a basket measuring the inflation rate for farmers
include? Why doesn’t the BLS calculate the price levels for a market basket approximating
the purchases of farmers? [LO 25.3]
Answer: A basket for farmers might include many of the goods we normally buy—bread or
jeans, for example—but it might include fewer eggs or vegetables than the basket for the
average urban consumer. (Farmers would be able to raise or grow these things themselves.)
The market basket probably also would include fertilizers and seeds to grow crops. The BLS
does not measure price increases for farmers because less than 1 percent of the current
American population are farmers. It would be a lot of work and effort to explicitly measure
the price level for such a small segment of the population.
6. Does the CPI represent the actual change in the cost of living for any given household?
Explain why or why not. [LO 25.3]
Answer: No. The CPI measures the cost living for an average (urban) household. Every
household consumes slightly different types of goods, which may be more or less expensive
than another household’s consumption basket. The CPI measures the cost of living for a
typical household, but individual households may experience inflation that is higher or lower
than that measured by the change in the CPI.
25-2
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, Chapter 25 - The Cost of Living
7. Suppose wages rise in China, leading to an increase in the price of toys imported from China.
How would this change affect the CPI, PPI, and the GDP deflator in the United States? [LO
25.4]
Answer: In the United States, imported Chinese toys are part of the CPI (since Chinese toys
are part of the basket of goods and services an average household might consume) but are not
part of the GDP deflator (since Chinese toys are not part of the U.S. GDP). Typically, toys are
not used as inputs for producers, so they would not be part of the PPI either. Thus, the U.S.
CPI would rise, but the PPI and GDP deflator would be unchanged. In China, if all of these
toys are exported, the CPI (and PPI) would not change, but the GDP deflator would rise. Of
course, an increase in wages would likely affect other industries outside of exporting sectors,
leading to increases in the CPI and PPI of China as well.
8. If the growth rate in nominal income is larger than the inflation rate (as measured by the
change in the CPI or the GDP deflator), has the real value of income grown? [LO 25.4]
Answer: Any time a nominal value is rising faster than the inflation rate, the real value will
be rising. The intuition is that real income is rising by the rate of nominal income growth but
falling by the rate of inflation. As long as nominal income growth outpaces inflation, real
incomes will be rising. To convince yourself of this, try a simple numerical example. Think
back to the equation earlier in the chapter for the value of 1969 income in 2021 dollars:
1969real2021 = 1969nominal × (CPI2021/CPI1969)
To make the calculations easier, suppose 1969nominal = 10,000 and CPI1969 = 100. Now
suppose 2021nominal rises by 10% over 1969nominal and CPI2021 rises 5% over CPI2021:
2021nominal = 11,000 (10% higher than 1969), and CPI2021 = 105 (5% higher than 1969)
Now calculate 1969real and see whether it is higher or lower than 2021real:
2021real = 2021nominal = 11,000
1969real = 10,000 × (105/100) = 10,500
So, real income has risen between 1969 and 2021. You can try this with any combination of
numbers. As long as nominal income is rising faster than the CPI, 2021real will be greater than
1969real.
9. What is the better measure of inflation to determine how much should be paid to employees
for cost-of-living adjustments: the Producer Price Index (PPI) or the CPI? Why? [LO 25.5]
Answer: Remember that the typical employee, when he or she leaves work, becomes a
typical consumer. Thus, an employee’s cost of living is closely approximated by the CPI, and
therefore employee’s wages should be adjusted by the CPI, not the PPI.
25-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
