# Inflation and CPI

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## Definitions

Inflation is an increase in the overall level of prices in the economy. CPI(Consumer Price Index)is a measure of the overall cost of the goods and services bought by a typical consumer.

## Sample Questions

**Q** Suppose the interest rate on new issues of Canada Savings Bonds is 5% per year and the federal income tax rate on nominal interest earnings is 40%. An investor's after-tax nominal rate of return on Canada Savings Bonds is then .....?

**A** that's just 5%*(1 - 40%) = 3% = 0.03

**Q** Suppose a study found that the real entry-level wage for graduates of a certain university declined by 8 percent between 1992 and 1999. The nominal entry-level wage in 1999 was $20.00 per hour. CPI values were 0.926 in 1992 and 1.088 in 1999. Assuming that the findings are correct, what was the nominal entry-level wage in 1992?

**A** so first you calculate inflation (1.088 - 0.926) / 0.926, and plug inflation into the equation "nominal rate = real rate + inflation, where real rate = -0.08 (the 8% decreases in real wage). Then we know nominal rate change = 9.49%. Now we use 20/(1 + 0.0949) = 18.2657.

**Q** In 1967, the Canadian consumer price index was 18 (2002 = 100) and in 1999 it was 93. From these figures we can conclude that Canadian prices increased by about __________ between 1967 and 1999.

**A** Price increase can be calculated by (93-18)/18 * 100 = 417%

**Q** If the consumer price index (CPI) was 100 in 2002 and 111.5 in 2007, and a typical household's income was $35,000 in 2002 and $39,025 in 2007, then between 2002 and 2007, real household income ...

A. increased; B. decreased; C. may have increased or decreased; D. can not be determined; E. was constant

**A** Inflation is 11.5%, and income goes up by the exact amount , so real income constant.