Consider that the CPI market basket includes two goods (X and Y), and the spending on X constitutes 70% of the overall consumer spending, while the remainder is allocated to Y.

If the price of Y increases by 10% while the price of X decreases by 10% then, all else held constant,

a. The CPI increases
b. The CPI decreases
c. The CPI remains unchanged

Question

07-04-2020
Business

contestada

Consider that the CPI market basket includes two goods (X and Y), and the spending on X constitutes 70% of the overall consumer spending, while the remainder is allocated to Y.

If the price of Y increases by 10% while the price of X decreases by 10% then, all else held constant,

a. The CPI increases
b. The CPI decreases
c. The CPI remains unchanged

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Parrain Parrain · Answer 1 · 2020-04-09T03:15:00+02:00

Answer: b. The CPI decreases

Explanation:

The Consumer Price Index (CPI) measures any change in the price level of a weighted average market basket of consumer goods and services.

It is stated that Good X constitutes 70% of consumer spending and Good Y constitutes the remainder which would be 30%.

If X decreases by 10% and Y increases by 10%, what would happen to the CPI?

Because the CPI is a weighted average, we can use the following,

Change in CPI = 0.7(-0.1) + 0.3(0.1)

= -7 + 3

= -4%

This means that the CPI will DECREASE by 4% because the price decrease occured in the Good with the higher Consumer Budget share.

andromache andromache · Answer 2 · 2022-04-05T15:07:05+02:00

In the case when the price of Y increases by 10% while the price of X decreases by 10% then, all else held constant so here CPI should decrease.

Impact on CPI:

Weight of Good X = 70%

Weight of Good Y = 30%

Since price of X declines by 10% and price of Y increases by 10%, the overall impact on CPI provided

Impact on CPI = ( Weight of X * Change in Price ) + ( Weight of Y * Change in Price )

Impact on CPI = ( 0.7 * -0.1 ) + ( 0.3 * 0.1 )

Impact on CPI = -4.00%

Therefore, CPI Decreases.

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