 # 1.(40 points total) The Peanuts comic below motivated parts a) an...

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a)(5 points) Snoopy mentions that bread is 39 (39 cents) per loaf referring to the price of bread back in August of 1970. Using the CPI data below, calculate what the real price, in terms of 1982-1984 dollars, of a loaf of bread is (this is in base period prices).

CPI

To find out real price in Aug 1970 in terms of Aug 1982-84 prices
Multiply old price * new price index which gives
0.39*100 = 39
And divide the answer with the old price index which is given as 39
39/39 = \$1 is the real price of a loaf of bread
Real price of loaf of bread in terms of 1982-84 prices
= nominal price * (CPI base year/CPI in 1970)
= 0.39 * (100/39)= \$1

b)(5 points) Now do the same exercise as above, but instead of using the CPI price index, use the Personal Consumption Expenditure price index (below). That is, what is the real price of a loaf of bread now using the PCE price index? Why it so different than your answer in part a) above?

PCE Price Index

Here the base year is given as 1990 and the PCE-PI in Aug 1970 is at 22.508. Using this and the nominal price of loaf of a bread in Aug 1970 to be 39 cents, we have the real price of a loaf of bread to be
Real price of loaf of bread in terms of 1990 prices we have
= 0.39 * (100/22.508 ) = 39/22.508 = \$1.73
It is so different than the answer in part (a) because, the base year is different and the PCE-PI is more consistent with the actual consumer behavior and the weights are allocated more efficiently in PCE than in CPI....

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