Economics 11

Spring 2005

Due Wed March 2, 2005 Homework 6

Chapter 11 Measuring the Cost of Living

Problems and Applications

Answer the question on the bottom of page 234.

What is $5 in 1914 worth today (in this problem, 2001) $5 x (177/10) = $88.50 per day.

An auto worker today earns about $30 per hour (not including fringe benefits) or about $240 per day.

4, 6, 7, 9 (income tax brackets are the percent of your income you pay to the government as income taxes), 11

4.a. If the cost purely represented an increase in quality, then there was no increase in the CPI as a result of this action.

b. The argument in favor is that by reducing pollution, the public is getting a better product; one that reduces pollution. Public health is improved. The arguments against it is that there is no guarantee that the increased cost was exactly equal to the value of the reduced pollution. Suppose one gram of pollution was eliminated at a cost of $100 million. That would suggest that there was a very large cost to eliminate a small amount of pollution, especially if the pollutant eliminated did not cause much damage to health or the environment. In that case, the increased cost should be reflected in an increase in the CPI.

6.a The price of the NYT rose by .75/.15-1 = 400%

b. The wage increased by 14.26/3.36-1 = 324%

c. In 1970 a worker earning $3.36 per hour earned 5.6 cents per minue (3.36/60) . She had to work about 2.7 minutes to buy a New York Times. In 2000 a worker earning $14.26 earned 23.8 cents per minute and had to work 3.15 minutes to buy a Times.

d. Workers’ purchasing power in terms of newspapers fell.

7. If the elderly consume the same market basket as everyone else, their standard of living will increase each year if the CPI overstates actual inflation.

b. The elderly consume more health care than younger people and health care costs rise faster than the overall CPI. The standard of living of the elderly will therefore fall over time as an increasing share of their income is devoted to health expenditures, which are increasing faster than the prices of other goods.

9. If inflation pushed people into higher tax brackets, real tax revenue would rise over time.

Say at an income level of $50,000, the tax bracket is 15%. That family would pay .15 x 50,000 = $7,500 in income taxes and have an after tax income of $42,500. Suppose inflation is 10%. The family’s income is now $55,000. But if that family is now in a tax bracket of 17%, they pay .17 x $55,000 = $9,350 and has an after tax income of $45,560. But the cost of a bundle of goods that use to cost $42,000 now costs 10% more, or $46,200. Their real income has fallen and real tax revenues have risen.