Question

Assume that you live in a simple economy in which only three goods are produced and traded: Cashews, pecans and almonds. Suppose that on January 1st 2105, cashews sold for $12.50 per pound, pecans were $4.00 per pound, and almonds were $5.50 per pound. At the end of the year you discover that the cashew crop was lower than expected and that cashew prices had increased to $17.00 per pound, but pecan prices stayed at $4.00 and almond prices has actually fallen to $3.00. Can you say what happened to the overall "price level"? How might you construct a measure of the "change in price level"? What additional information might you need to construct your measure?

Answer 1

Explanation:

The information given in the question can be represent in a table format for better understanding with the additional columns as follows:

Items Weights Q₀ Prices P₀ Prices P₁ P₀Q₀ P₁Q₀

Cashew 1 $12.50 $17.00 $12.50 $17.00

Pecans 1 $4.00 $4.00 $4.00 $4.00

Almonds 1 $5.50 $3.00 $5.50 $3.00

Total $22 $24

Can you say what happened to the overall "price level"?

The changes in overall price level can be a result of a condition termed as inflation rate

How might you construct a measure of the "change in price level"?

To construct a measure of the change in price level; we need to determine the consumer price index (CPI).

The consumer price index can be determined by using the relation:

`=\mathbf{(Sum \ of \ P_1Q_0)/(Sum \ of \ P_oQ_o)*100 }`

`= \mathbf{(24)/(22)*100 }`

= 109.0%

consumer price index (CPI) is 109.0% ; This implies that there is a 9.9% inflation in the economy.