a. The cost of the basket in
the base year is $200 + $600 + $100 + $50 = $950. In the
subsequent year the same basket of goods costs $220 + $640 + $120 +
$40 = $1020. The CPI in the subsequent year equals the cost
of the basket in that year relative to the base year:.
Since the CPI in the base year is 1.000, the rate of inflation
(equal to the percentage increase in the CPI) between the base year
and the subsequent year is 7.4%.

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Step 2 of 2

b. The family’s nominal income
rose by 5%, which is less than the increase in the family’s cost of
living. The family is thus worse off in terms of real
purchasing power.