Question

Consider the effects of inflation in an economy composed of only two people: Charles, a bean farmer, and Dina, a rice farmer. Charles and Dina both always consume equal amounts of rice and beans. In 2016 the price of beans was $1, and the price of rice was $4.
1. Suppose that in 2017 the price of beans was $2 and the price of rice was $8.
(a) Inflation= ?%
(b) Indicate whether Charles and Dina were better off, worse off, or unaffected by the changes in prices.
Better Off
Worse Off
Unaffected
Charles
Dina
2. Now suppose that in 2017 the price of beans was $2 and the price of rice was $4.80.
(a) In this case, inflation= ?%
(b) Indicate whether Charles and Dina were better off, worse off, or unaffected by the changes in prices.
Better Off
Worse Off
Unaffected
Charles
Dina
3. Now suppose that in 2017, the price of beans was $2 and the price of rice was $1.60.
(a) In this case, inflation= ?%
(b) Indicate whether Charles and Dina were better off, worse off, or unaffected by the changes in prices.
Better Off
Worse Off
Unaffected
Charles
Dina
4. What matters more to Charles and Dina?
The overall inflation rate
or
The relative price of rice and beans

Answer 1

Answer:

1) Suppose that in 2017 the price of beans was $2 and the price of rice was $8.

• a) inflation rate = 100%
• b) both are unaffected

old price of beans = $1, new price $2, inflation rate 100%

old price of rice = $4, new price $8, inflation rate 100%

The inflation rate measures the change in the general price level of an economy during a certain period of time, in this case during a year from 2016 to 2017.

Since Gilberto produces beans and Juanita produces rice, and the price of both of their products increase equally (100%), then the inflation rate will not affect them. Their consumption levels also remain the same, no one decided to consume more of one product and less of the other.

2) Now suppose that in 2017 the price of beans was $2 and the price of rice was $4.80.

• a) 60%
• b) Charles is better off while Dina is worse off

old price of beans = $1, new price $2, inflation rate 100%

old price of rice = $4, new price $4.80, inflation rate 20%

average inflation rate = 60%

Since Charles produces beans, and the price of his products increased a lot, he will be better off, while Dina will be worse off since the price of rice increased much less.

3. Now suppose that in 2017, the price of beans was $2 and the price of rice was $1.60.

• a) 20%
• b) Charles will be better off, Dina will be worse off

old price of beans = $1, new price $2, inflation rate 100%

old price of rice = $4, new price $1.60, inflation rate -60%

average inflation rate = 20%

4) What matters more to Charles and Dina?

• The relative price of rice and beans is more important to Charles and Dina.

Answer 2

The inflation in 2017 was 100% and both Charles and Dina are unaffected.

1. In 2016 the price of beans was $1, and the price of rice was $4 but in 2017, the price of beans was $2 and the price of rice was $8.

This implies that the market basket has increased from $5 to $10. The inflation will be: = (10 - 5) / 5 × 100  = 100%

Therefore, both of them are unaffected by the increase in price.

2. If the price of beans was $2 and the price of rice was $4.80, then the market basket is $6.80. Therefore, the inflation will be:

= (6.80 - 5) / 5 × 100

= 36%

Inflation is 36%. In this case, Charles is better off because the price of beans has doubled.

3. The Inflation based on the information given will be:

= (3.60 - 5) / 5 × 100

= -28%

In this case, Charles is still better off and there's a fall in inflation by 28%.

4. It should be noted that the relative price of rice and beans matters more to Charles and Dina.

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