Question 2 (5 marks)

Economists use the term Inflation to describe a situation in which the economy's overall price level is rising.

a)Briefly explain how the Consumer Price Index (CPI) is used to measure inflation. (1 mark)

b) Briefly explain why the Reserve Bank of Australia targets inflation. (1 mark)

c) Suppose that the residents of Clothing and spend all of their income on dresses, hats and shoes.In 2015, they buy four dresses for $900, five hats for $600 and two pairs of shoes for $500, In 2016 they buy five dresses for $1,000, five hats for $700 and four pairs of shoes for $700 and if the base year is 2015:

i.Calculate the CPI in for year 2015. (1 mark)

ii.Calculate the CPI in for year 2016. (1 mark)

iii.Calculate the inflation rate in 2016. (1 mark)

[Answer and show workings here]