Chapter 1: Preliminaries
QUESTIONS FOR REVIEW
4. In Example 1.3, what economic forces explain why the real price of eggs has fallen while the real price of a college education has increased? How have these changes affected consumer choices?
The price and quantity of goods (e.g., eggs) and services (e.g., a college education) are determined by the interaction of supply and demand. The real price of eggs fell from 1970 to 1985 because of either a reduction in demand (consumers switched to lowercholesterol food), a reduction in production costs (improvements in egg production technology), or both. In response, the price of eggs relative to other foods decreased. The real price of a college education rose because of either an increase in demand (e.g., more people recognized the value of an education), an increase in the cost of education (e.g., increase in staff salaries), or both.
6. The price of longdistance telephone service fell from 40 cents per minute in 1996 to 22 cents per minute in 1999, a 45percent (18 cents/40 cents) decrease. The Consumer Price Index increased by 10percent over this period. What happened to the real price of telephone service?
Let the CPI for 1996 equal 1 and the CPI for 1999 equal 1.1, which reflects a 10% increase in the overall price level. To find the real price of telephone service in each period, divide the nominal price by the CPI for that year. For 1996, we have 40/1 or 40 cents, and for 1999, we have 22/1.1 or 20 cents. The real price therefore fell from 40 to 20 cents, a 50% decline.
EXERCISES
2. The following table shows the average retail price of butter and the Consumer Price Index from 1980 to 2001.
ˇ

1980

1985

1990

1995

2000

2001








CPI

100

130.58

158.62

184.95

208.98

214.93

Retail Price of butter

$1.88

$2.12

$1.99

$1.61

$2.52

$3.30

(salted, grade AA, per lb.)







a. Calculate the real price of butter in 1980 dollars. Has the real price increased/decreased/stayed the same since 1980?
Real price of butter in year X = .
1980 1985 1990 1995 2000 2001
$1.88 $1.62 $1.25 $0.87 $1.21 $1.54
Since 1980 the real price of butter has decreased.
b. What is the percentage change in the real price (1980 dollars) from 1980 to 2001?
Percentage change in real price from 1980 to 2001 = .
c. Convert the CPI into 1990 = 100 and determine the real price of butter in 1990 dollars.
To convert the CPI into 1990=100, divide the CPI for each year by the CPI for 1990. Use the formula from part (a) and the new CPI numbers below to find the real price of milk.
New CPI 1980 63.1 Real price of milk 1980 $2.98
1985 82.3 1985 $2.58
1990 100 1990 $1.99
1995 116.6 1995 $1.38
2000 131.8 2000 $1.91
2001 135.6 2001 $2.43
d. What is the percentage change in the real price (1990 dollars) from 1980 to 2001? Compare this with your answer in (b). What do you notice? Explain.
Percentage change in real price from 1980 to 2001 = . This answer is almost identical (except for rounding error) to the answer received for part b. It does not matter which year is chosen as the base year.
3. At the time this book went to print, the minimum wage was $5.15. To find the current minimum wage, go to http://www.bls.gov/cpi/home.htm
Click on: Consumer Price Index All Urban Consumers (Current Series)
Select: U.S. All items
This will give you the CPI from 1913 to the present.
a. With these values, calculate the current real minimum wage in 1990 dollars.
real minimum wage 1998 in 1990 $ = .
b. What is the percentage change in the real minimum wage from 1985 to the present, stated in real 1990 dollars?
Assume the minimum wage in 1985 was $3.35. Then,
real minimum wage 1985 in 1990 $ = .
The percentage change in the real minimum wage is therefore
