Question
a) Say that in an economy at the start of year 1 the consumer price index was 94, in year 2 it was 100, in
a) Say that in an economy at the start of year 1 the consumer price index was 94, in year 2 it was 100, in year 3 it was 103, in year 4 it was 111, and in year 5 it was 110. What was the annual inflation rate in each year? In this kind of data, what is the name for year 2 and what does that mean?
b) Briefly explain the idea of how an index like the CPI is calculated. Two important considerations for researchers constructing an index like this are substitution bias and new goods or quality bias. Give a plausible real-world example of a situation in which those two issues might arise.
c) Suggest and explain a couple of reasons why people's expectations about future inflation might influence their behavior and choices in the present in ways that may make those expectations self-fulfilling.
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