# Inflation and CPI

## 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.