Interpreting Price Changes with a Fixed Basket
An economist is studying two different cities, City X and City Y, over a one-year period. To measure the change in the general price level, the economist uses the exact same 'shopping basket' of typical goods and services for both cities.
- In City X, the price of housing, a major expense in the basket, increased by 20%. The prices of all other goods and services in the basket remained unchanged.
- In City Y, the price of housing remained unchanged. However, the prices of nearly all other items in the basket—such as food, transportation, and entertainment—each increased by a small amount, around 2-3%.
After calculating the total cost of the identical basket in each city at the end of the year, the economist finds that the overall percentage increase in the basket's cost was exactly the same for both City X and City Y.
Based on the principles of the 'shopping basket' method, explain how it is possible for these two very different patterns of price changes to result in the same overall measure of price increase.
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Related
Consumer Price Index (CPI)
An economist wants to measure the change in the cost of a 'standard grocery run' between two years.
- In Year 1, the basket consists of 1 loaf of bread ($3), 1 gallon of milk ($4), and 1 dozen eggs ($2). The total cost is $9.
- In Year 2, the economist observes that bread now costs $4 and milk costs $3.50. They also notice that many people are now buying a half-dozen eggs for $1.50 instead of a full dozen. The economist calculates the new basket cost as $4 (bread) + $3.50 (milk) + $1.50 (half-dozen eggs) = $9.
The economist concludes that there has been no overall change in prices. What is the fundamental error in this approach to measuring the change in the general price level?
Applying the Shopping Basket Method
Critique of a Price Level Calculation
To accurately measure the change in the general price level between two periods using the 'shopping basket' method, the quantities of goods and services in the basket should be adjusted in the second period to reflect the most current consumer purchasing habits.
A researcher wants to measure the change in the overall cost of typical household expenses in a town between last year and this year. Arrange the following steps in the correct logical order to accurately apply the 'shopping basket' method for this purpose.
Evaluating a Method for Price Measurement
An economist is using the 'shopping basket' method to measure the change in the general price level between two years. Match each action taken by the economist with the correct description of its purpose or validity within this method.
A simple shopping basket is defined as containing 2 loaves of bread and 1 gallon of milk. In a base year, the total cost of this basket was calculated. In the following year, the price of bread is $3.50 per loaf and the price of milk is $5.00 per gallon. To measure the change in the general price level, the cost of this identical basket in the following year would be $____.
Calculating Price Changes for a Town's Representative Basket
Interpreting Price Changes with a Fixed Basket