The price of computers has fallen substantially over the past two decades. Use this drop in price to explain why the Consumer Price Index is likely to overstate substantially the cost-of-living index for individuals who use computers intensively.

The Consumer Price Index (CPI) is likely to overstate substantially the cost-of-living index for individuals who use computers intensively because

A) the CPI allows consumers to purchase more of goods whose price has fallen, increasing total consumer expenditures.

B)the CPI allows consumers to purchase less of goods whose price has risen but not to purchase more of goods whose price has fallen.

C) the CPI uses fixed weights that understate the importance to consumers of goods whose prices have fallen.

D) the CPI uses a weighting system that gives less weight to goods whose prices have risen and more weight to goods whose prices have fallen.

E. the CPI compares the cost of current purchases at current-year prices with the cost of current purchases at base-year prices, which were higher for computers.

Question #2

Suppose Naomi consumes two goods: good 1 and good 2. Last year, the price of good 1 was $2.00 and the price of good 2 was $3.20. Given these prices, Naomi maximized satisfaction consuming bundle A, as indicated in the figure to the right. However, this year, the price of good 1 has increased to $6.00 and the price of good 2 has changed to $2.40. Given these prices, Naomi would be equally well off at consumption bundle B.

100- 90- 80- 70- 60- B 50 40- 30- A 20 10- U L2 41 0- 0 10 20 30 70 40 50 60 Good 1 80 90 100