A basket of goods costs $80 in the base year and $100 in the current year. What is the price index for the current year?
125
✓
80
120
25
Correct Answer
125
The index equals the current cost divided by the base-year cost, times 100: 100 / 80 x 100 = 125. An index of 80 comes from dividing the wrong way, putting the current cost on the bottom. An index of 120 adds the $20 dollar increase to 100 instead of scaling it by the base cost. A value of 25 is the percentage increase, not the index level.
Category: Calculating Inflation
Question 2
Over one year, a country's price index drops from 120 to 114. Calculate the inflation rate for that year, rounded to one decimal place.
-6.0%
-5.0%
✓
5.0%
-5.3%
Correct Answer
-5.0%
The inflation rate is the change in the index divided by the starting value: (114 - 120) / 120 = -0.05, or -5.0%, so prices fell and the economy had deflation. A rate of -6.0% treats the 6-point drop as a percentage. A rate of 5.0% has the right size but the wrong sign. A rate of -5.3% divides by the ending value of 114 instead of the starting value.
Category: Calculating Inflation
Question 3
A price index rises from 150 to 165 over one year. What is the inflation rate? Round to one decimal place.
15.0%
9.1%
10.0%
✓
110.0%
Correct Answer
10.0%
The inflation rate is (165 - 150) / 150 = 0.10, or 10.0%. A rate of 15.0% simply subtracts the index numbers, which only works as a shortcut when the starting index is 100. A rate of 9.1% divides by the ending value instead of the starting value. A figure of 110.0% is the ratio of the two indexes, not the percentage change.
Category: Calculating Inflation
Question 4
A savings account pays 3% nominal interest per year while inflation is 5%. What is the real interest rate on the account?
8%
2%
3%
-2%
✓
Correct Answer
-2%
The real interest rate is the nominal rate minus the inflation rate: 3% - 5% = -2%, so the saver loses purchasing power each year. A rate of 8% adds inflation instead of subtracting it. A rate of 2% has the right size but the wrong sign. A rate of 3% is the nominal rate, which ignores inflation entirely.
Category: Real Versus Nominal
Question 5
Which price index tracks inflation in the labor market by measuring what employers pay workers?
Employment Cost Index
✓
Producer Price Index
Consumer Price Index
International Price Index
Correct Answer
Employment Cost Index
The Employment Cost Index measures how the cost of labor changes over time, so it captures wage inflation. The Producer Price Index tracks prices firms pay for supplies and inputs. The Consumer Price Index tracks the cost of a basket of household purchases. The International Price Index tracks prices of imported and exported merchandise.
Category: Price Indexes and Bias
Question 6
In U.S. history, periods of very low inflation or outright deflation have tended to coincide with what?
Wartime spending booms
Recessions and depressions
✓
Periods of rapid growth
Times of low unemployment
Correct Answer
Recessions and depressions
When an economy slumps, unemployment rises and total demand weakens, which holds down the price level; the Great Depression of the 1930s brought severe deflation. Wartime spending booms have been followed by inflation surges, as after both World Wars. Periods of rapid growth are not linked to deflation; strong growth, as in the 1960s, has often brought rising inflation. Times of low unemployment usually come with rising, not falling, inflation pressure.
Category: Inflation History
Question 7
To see the underlying trend in prices, economists often watch a core index that leaves out which two categories because their prices swing sharply?
Housing and medical care
Clothing and education
Food and energy
✓
Transportation and recreation
Correct Answer
Food and energy
Food and energy prices can jump or drop quickly because of weather, supply shocks or events like hurricanes, so a core index excludes them to reveal more persistent inflation. Housing and medical care are kept in the core index. Clothing and education are also kept. Transportation and recreation remain in the core index as well, apart from the energy items such as gasoline.
Category: Price Indexes and Bias
Question 8
When beef prices jump, many shoppers buy more chicken instead. How does a fixed-basket price index that ignores this switching measure the change in the cost of living?
It understates the increase
It measures the increase exactly
It shows no change at all
It overstates the increase
✓
Correct Answer
It overstates the increase
A fixed basket assumes people keep buying the same amount of beef, so it gives the price jump more weight than it really has in household spending; this is substitution bias, and it overstates the rise in the cost of living. It understates the increase reverses the direction of the bias. It measures the increase exactly ignores the switching that the fixed basket misses. It shows no change at all is wrong because the beef price rise still raises the index.
Category: Price Indexes and Bias
Question 9
When inflation is high, which group tends to bear its costs most heavily because it has the fewest ways to protect itself?
Financially unsophisticated people and small businesses
✓
Large banks holding adjustable-rate loans
Investors who buy indexed government bonds
Retirees whose benefits rise with the CPI
Correct Answer
Financially unsophisticated people and small businesses
Indexing is only partial, and sophisticated investors and large businesses can hedge against inflation, so the costs fall hardest on people and small firms without those tools. Large banks holding adjustable-rate loans are protected because the interest rate moves with inflation. Investors who buy indexed government bonds are promised a real return. Retirees whose benefits rise with the CPI are shielded by that indexing.
Category: Winners and Losers
Question 10
Which person is most likely to benefit when inflation turns out higher than expected?
A bank that made a fixed-rate loan
A homeowner repaying a fixed-rate mortgage
✓
A retiree with a fixed nominal pension
A family keeping its savings in cash
Correct Answer
A homeowner repaying a fixed-rate mortgage
A borrower with a fixed interest rate repays the loan with dollars that buy less than expected, so unexpected inflation shifts purchasing power toward the homeowner. A bank that made a fixed-rate loan is the mirror-image loser. A retiree with a fixed nominal pension sees each payment buy less. A family keeping its savings in cash loses purchasing power because cash earns no interest.
Category: Winners and Losers
Question 11
A worker earned $15 per hour in the base year, when the price index was 100. Years later she earns $18 per hour and the price index is 120. What is her later wage expressed in base-year dollars?
$21.60
$18.00
$15.00
✓
$12.50
Correct Answer
$15.00
To convert to base-year dollars, divide the nominal wage by the index and multiply by 100: 18 / 120 x 100 = $15.00, so her real wage has not changed. A value of $21.60 multiplies by the index ratio instead of dividing. A value of $18.00 is the nominal wage with no inflation adjustment. A value of $12.50 deflates the original $15 wage instead of the new $18 wage.
Category: Real Versus Nominal
Question 12
A union contract grants an annual raise of 'COLA plus 2%'. If inflation for the year is 4%, how large is the raise?
4%
2%
8%
6%
✓
Correct Answer
6%
A cost-of-living adjustment matches the inflation rate, so the raise is 4% for inflation plus the extra 2%, for 6% in total. A 4% raise counts only the COLA part. A 2% raise counts only the extra amount. An 8% raise wrongly doubles the inflation rate.
Category: Indexing
Question 13
Before U.S. income tax thresholds were indexed, rising prices could move a household into a higher tax rate band even when its real income had not grown. What was this effect called?
Bracket creep
✓
Substitution bias
Menu cost
Deflationary spiral
Correct Answer
Bracket creep
Bracket creep happened because tax brackets were set in nominal dollars, so inflation alone could raise a household's tax rate; legislation passed in 1981 indexed the brackets to end it. Substitution bias is a flaw in fixed-basket price indexes. A menu cost is the cost a firm pays to change its posted prices. A deflationary spiral is a cycle of falling prices and falling spending.
Category: Indexing
Question 14
A price index is constructed so that its value in the base year equals what number?
50
100
✓
1,000
Correct Answer
100
By convention the base year's index is set to 100, so an index of 110 in a later year means prices are 10% higher than in the base year. An index of 50 would mean prices were half their base-year level, which cannot describe the base year itself. An index of 0 would make every percentage comparison impossible. An index of 1,000 is not the convention for standard U.S. price indexes.
Category: Calculating Inflation
Question 15
A student's basket contains 10 pizzas at $8 each and 4 movie tickets at $10 each. The next year pizzas cost $9 and movie tickets still cost $10. What is the inflation rate for the basket? Round to one decimal place.
12.5%
6.3%
8.3%
✓
7.7%
Correct Answer
8.3%
The basket costs 10 x 8 + 4 x 10 = $120 in the first year and 10 x 9 + 4 x 10 = $130 in the second, so inflation is 10 / 120 = 8.3%. A rate of 12.5% is the change in the pizza price alone. A rate of 6.3% is a simple average of the two price changes, which ignores how much of each item is bought. A rate of 7.7% divides the $10 increase by the second year's cost instead of the first.
Category: Calculating Inflation
Question 16
Why do adjustable-rate mortgages often start with a lower interest rate than fixed-rate mortgages?
They are repaid over a shorter term
The government pays part of the interest
Borrowers must make a larger down payment
The lender is protected if inflation rises
✓
Correct Answer
The lender is protected if inflation rises
Because the rate on an adjustable-rate mortgage rises along with market interest rates and inflation, the lender bears less inflation risk and can charge a smaller risk premium at the start. They are repaid over a shorter term is not what defines this kind of loan. The government pays part of the interest describes a subsidy, not the adjustable feature. Borrowers must make a larger down payment is not a built-in feature of adjustable-rate loans.
Category: Indexing
Question 17
Suppose every price, wage, savings balance and interest rate in an economy rises by exactly 10% over a year. What happens to the real purchasing power of households?
It stays the same
✓
It falls by 10%
It rises by 10%
It falls by 20%
Correct Answer
It stays the same
If all money values rise together, every household can buy exactly what it could before, so nominal numbers change but real purchasing power does not; inflation causes harm mainly because money values do not all adjust together. It falls by 10% would be true only if incomes and savings stayed fixed while prices rose. It rises by 10% confuses higher nominal income with more buying power. It falls by 20% has no basis in the scenario.
Category: Real Versus Nominal
Question 18
A basket cost $200 in the base year. This year the price index for that basket is 115. What does the basket cost this year? Round to the nearest dollar.
$215
$230
✓
$315
$174
Correct Answer
$230
An index of 115 means the basket costs 1.15 times its base-year cost: 200 x 1.15 = $230. A cost of $215 adds 15 dollars instead of 15 percent. A cost of $315 adds the index number itself to the base cost. A cost of $174 divides by 1.15 instead of multiplying.
Category: Calculating Inflation
Question 19
When the U.S. government sells bonds that promise a set real return above whatever inflation occurs, what incentive does it give up compared with fixed-rate bonds?
Raising taxes to repay its debt
Borrowing from foreign investors
Repaying its debt with inflated dollars
✓
Lowering interest rates over time
Correct Answer
Repaying its debt with inflated dollars
With fixed-rate bonds, inflation lets a government repay what it owes in dollars worth less, which gives it a reason to tolerate inflation; indexed bonds remove that gain. Raising taxes to repay its debt is a separate choice unrelated to how the bond is indexed. Borrowing from foreign investors can happen with either kind of bond. Lowering interest rates over time is not something an indexed bond rules out.
Category: Indexing
Question 20
A new laptop model sells for the same price as last year's but runs faster and stores more. If a price index treats the two laptops as identical products, which bias results?
Substitution bias
Sampling error
Base-year bias
Quality/new goods bias
✓
Correct Answer
Quality/new goods bias
Quality/new goods bias arises when a fixed basket misses improvements in products or the arrival of new ones, so it overstates the rise in the cost of living. Substitution bias comes from ignoring how consumers switch away from goods whose relative prices rise. Sampling error is a statistical issue from surveying only part of a population, not a quality problem. Base-year bias is not a standard measurement problem, because the choice of base year does not change measured inflation rates.
Category: Price Indexes and Bias