Question

Suppose that the CPI does indeed overstate the rate of inflation. When the CPI increases by 5%

and household incomes increase by 5%, we should conclude that the real incomes of
households:
A. increased.
B. stayed constant.
C. decreased.
D. increased more slowly than inflation.

Answer 1

A) increased.

Step-by-step explanation:

If the CPI overstates the inflation rate, it means that the CPI is higher than the inflation rate. If the CPI = 5%, then the inflation rate must be lower than 5%. If the household incomes increased by 5%, then the real income (nominal income discounted by inflation rate) should have increased.

For example, the inflation rate is lower than 5%, so lets say it is 4%. Then the real income increased by: 5% / 4% = 1.25% - 1% = 0.25%