Total points: 15

Exercise 1 (7 points)

A.Assume that in an economy only 3 goods are produced and consumed: beans, fruit, and fish. Suppose that on January 1, beans sold for $2.50 per pound, fish was $3.00 per pound, and fruit was $1.50 per pound. At the end of the year, beans prices had increased to $5.00 per pound, but fruit prices stayed at $1.50 per pound, and fish prices had actually fallen to $2.00. CPI basket is 10 lbs beans, 25 lbs fruit, 32 lbs fish. In January 1, households bought the CPI basket. At the end of the year, households bought 2 lbs beans, 15 lbs fruit, 45 lbs fish. What happened to the CPI inflation rate? Show and compute the commodity substitution bias. Explain the relationship between new goods and CPI measure of inflation. Use and present answer with 4 decimals.

B.During the early 1930s, there were a number of bank failures. What did this do to the money supply? Why? What could have reversed the change in the money supply as stated above?