Question

Let’s consider the effects of inflation in an economy composed of onlytwo people: Bob, a bean farmer, and Rita, a rice farmer. Bob and Ritaboth always consume equal amounts of rice and beans. In 2010, theprice of beans was $1, and the price of rice was $3.a. Suppose that in 2011 the price of beans was $2 and the price ofrice was $6. What was inflation? Was Bob better off, worse off, orunaffected by the changes in prices? What about Rita?b. Now suppose that in 2011 the price of beans was $2 and the priceof rice was $4. What was inflation? Was Bob better of , worse off,or unaffected by the changes in prices? What about Rita?

c. What matters more to Bob and Rita-the overall inflation rate orthe relative price of rice and beans?

Answer 1

a. Suppose that in 2011 the price of beans was $2 and the price of rice was $6. What was inflation? Was Bob better off, worse off, or unaffected by the changes in prices? What about Rita?

The inflation rate is 100% since the price of both rice and beans increased by 100%. Neither Bob nor Rita will be affected by this.

b. Now suppose that in 2011 the price of beans was $2 and the price of rice was $4. What was inflation? Was Bob better of , worse off,or unaffected by the changes in prices? What about Rita?

inflation rate = (0.5 x 100%) + (0.5 x 33.33%) = 66.67%

Bob is better off because the price of beans increased by 100%, while Rita will be worse off since the price of rice increased only by 33%.

c. What matters more to Bob and Rita-the overall inflation rate or the relative price of rice and beans?

the relative price of beans and rice