Imagine two economies, A and B. In Economy A, technological improvements are rare, and the basket of goods and services that households consume is essentially unchanged from one year to the next. In Economy B, technology improves fast, and every year households consume goods and services that are better than those consumed the year before (or that did not even exist previously, e.g., new drugs). In both economies, during the year 2015, the government measured inflation to be 2 percent, and nominal incomes also increased by 2 percent. (LO7)

a. According to the official inflation figures, by how much did real incomes increase in each of the economies?

b. If government statisticians missed or understated quality changes, in which of the two economies was inflation overstated? In which of the two was the true improvement in living standards understated?