Chapter 08- The Cost of Living

CHAPTER 8
THE COST OF LIVING

Solutions to End-of-Chapter Questions and Problems

Review Questions

1. If we want to measure changes in the cost of living, why don’t we track difference in each
household’s actual expenditures from one year to the next, rather than the difference in the
cost of a market basket? Offer several reasons why this method would fail to capture changes in
the overall price level accurately. [LO 8.1]

Answer:We don’t track changes in actual expenditures from year to year because we want
to be sure we are measuring changes in prices and not changes in quantities. Households
change the types and amounts of goods and services they buy for several reasons. First, as
certain goods become more expensive, consumers may substitute away to different goods
whose prices have not increased as rapidly. Furthermore, people’s consumption patterns
may change due to tastes or changes in income that have nothing to do with changing
prices. Finally, innovation can lead to the introduction of new products or improvements in
existing products. Changes in spending on these goods are difficult to attribute to simple
changes in price.

2. There are many different types of market baskets that economists measure. For
example, the market basket for consumers—called the Consumer Price Index—tracks
the prices associated with the typical consumer’s purchases of goods and services. The
Producer Price Index tracks the prices of the goods and servicespurchased by firms. A

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Chapter 08- The Cost of Living

third type of market basket is the Home Price Index, which tracks the value of residential
housing. In what scenarios would each of these market baskets be useful? [LO 8.1]

Answer: Measuring the cost of living for a typical consumer is probably best addressed
through a broad-based index like the CPI. Besides being helpful in examining price changes
that might affect businesses, the PPI is also useful as a gauge of future CPI inflation since
businesses typically pass on some of their increases in input costs to consumers. A Home
Price Index is useful for measuring differences in the cost of living between different cities. It
is well known that some cities like New York City and San Francisco are more costly to live in
than other regions of the country, but it is difficult to easily and accurately measure every
price difference between cities. By measuring the difference in housing prices, which are a
large portion of a typical household's budget and are also the budget item that varies most
widely from city to city, differences in the overall cost of living can be approximated.

3. Why is the list of the highest-grossing films of all time dominated by movies made within the
last 10 years? (Hint: Did The Star Wars: The Force Awakens, made in 2015, really sell
considerably more movie tickets than the classic Gone with the Wind, or is something else going
on?) [LO 8.2]

Answer: Given the price of tickets has risen over time, studios can make more money, in
nominal terms, selling tickets now than in the past. It’s a lot easier to sell $100 million worth
of tickets when tickets are $15 each than when they are only 8 cents apiece. A second
reason, although not related to the topic of prices, is that the population has grown over
time. In 1939, the year Gone with the Wind was released, the U.S. population was only
about 131 million; in contrast, the U.S. population in 2015 was 326 million. That’s 195
million additional ticket buyers now as opposed to 75 years ago.

4. How would you use the concept of the Consumer Price Index to compare prices across
different locations? [LO 8.2]

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Chapter 08- The Cost of Living

Answer:You could use the concept of the CPI to compare prices across locations by creating
a basket with the same goods in two different places and then measuring how the prices
changed in each basket over a set period of time. For example, if you wanted to compare
the prices in Iowa City and Kansas City, you would compare the prices of the same goods in
both cities over time.

5. What types of goods and serviceswould a basket measuring the inflation rate for farmers
include? Why doesn’t the BLS calculate the price levels for a market basket approximating the
purchases of farmers? [LO 8.3]

Answer:A basket for farmers might include many of the goods we normally buy—bread or
jeans, for example—but it might include fewer eggs or vegetables than the basket for the
average urban consumer. (Farmers would be able to raise or grow these things themselves.)
The market basket probably also would include fertilizers and seeds to grow crops. The BLS
does not measure price increases for farmers because less than 1 percent of the current
American population are farmers. It would be a lot of work and effort to explicitly measure
the price level for such a small segment of the population.

6. Does the CPI represent the actual change in the cost of living for any given household?
Explain why or why not. [LO 8.3]

Answer: No. The CPI measures the cost living for an average (urban) household. Every
household consumes slightly different types of goods, which may be more or less expensive
than another household’s consumption basket. The CPI measures the cost of living for a
typical household, but individual households may experience inflation that is higher or lower
than that measured by the change in the CPI.

7. Suppose wages rise in China, leading to an increase in the price of toys imported from China.
How would this change affect the CPI, PPI, and the GDP deflator in the United States? [LO 8.4]

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Chapter 08- The Cost of Living

Answer: In the United States, imported Chinese toys are part of the CPI (since Chinese toys
are part of the basket of goods and services an average household might consume) but are
not part of the GDP deflator (since Chinese toys are not part of the U.S. GDP). Typically, toys
are not used as inputs for producers, so they would not be part of the PPI either. Thus, the
U.S. CPI would rise, but the PPI and GDP deflator would be unchanged. In China, if all of
these toys are exported, the CPI (and PPI) would not change, but the GDP deflator would
rise. Of course, an increase in wages would likely affect other industries outside of exporting
sectors, leading to increases in the CPI and PPI of China as well.

8. If the growth rate in nominal income is larger than the inflation rate (as measured by the
change in the CPI or the GDP deflator), has the real value of income grown? [LO 8.4]

Answer: Any time a nominal value is rising faster than the inflation rate, the real value will
be rising. The intuition is that real income is rising by the rate of nominal income growth but
falling by the rate of inflation. As long as nominal income growth outpaces inflation, real
incomes will be rising. To convince yourself of this, try a simple numerical example. Think
back to the equation earlier in the chapter for the value of 1969 income in 2009 dollars:

1969real2009 = 1969nominal x (CPI2009/CPI1969)

To make the calculations easier, suppose 1969nominal = 10,000 and CPI1969 = 100. Now suppose
2009nominal rises by 10% over 1969nominal and CPI2009 rises 5% over CPI2009:

2009nominal = 11,000 (10% higher than 1969), and CPI2009 = 105 (5% higher than 1969)

Now calculate 1969real and see whether it is higher or lower than 2009real:

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Chapter 08- The Cost of Living

2009real = 2009nominal = 11,000

1969real = 10,000 x (105/100) = 10,500

So, real income has risen between 1969 and 2009. You can try this with any combination of
numbers. As long as nominal income is rising faster than the CPI, 2009real will be greater than
1969real.

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Chapter 08- The Cost of Living

9. What is the better measure of inflation to determine how much should be paid to
employees for cost-of-living adjustments: the Producer Price Index (PPI) or the CPI? Why? [LO
8.5]

Answer: Remember that the typical employee, when he or she leaves work, becomes a
typical consumer. Thus, an employee’s cost of living is closely approximated by the CPI, and
therefore employee’s wages should be adjusted by the CPI, not the PPI.

10. Why are people unlikely to buy Big Macs in the places where they are relatively cheap
according to purchasing power parity and sell them where they are relatively more expensive, in
order to make a profit? [LO 8.4, LO 8.6]

Answer: The transaction costs would be too high. It would be expensive to transport Big
Macs from one country to another just to make a few cents. Furthermore, there is little
resale market for used Big Macs, not to mention the fact that the Big Macs would spoil
quickly. Thus, we would not expect the price of Big Macs to equalize around the world.
Commodities like gold, however, are generally sold at very similar prices all over the globe,
since gold can be cheaply transported, easily resold, and doesn’t degrade over time.

11. In many poor countries, even middle-class families may have full-time servants, a luxury
reserved for only the very wealthiest households in rich countries like the United States. How
does the existence of low-cost domestic help affect PPP-adjusted GDP statistics in poor
countries? [LO 8.7, 8.8]

Answer: Domestic help is relatively cheap in poor countries, but due to immigration laws
and other factors, it cannot easily be imported into rich countries, so the price of domestic
help doesn’t tend to equalize across countries. Thus, since consumption baskets include
domestic help (and other services that can be provided cheaply in poor countries), prices
tend to be lower in poor countries. This tends to increase the PPP-adjusted GDP in poor
countries relative to non-adjusted GDP statistics.

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Chapter 08- The Cost of Living

12. Would Kentucky, a state with a very low cost of living, have a PPP-adjusted GDP higher or
lower than its GDP calculated without PPP-adjustment? Why? [LO 8.8]

Answer: Kentucky will have a higher GDP after adjusting for PPP. Since Kentucky has a low
cost of living, a given number of dollars will purchase more goods and services in Kentucky
than in a state with a higher cost of living. GDP without a PPP adjustment simply counts up
the number of dollars earned in Kentucky, while GDP with a PPP adjustment accounts for
how much those dollars can buy. Since dollars can buy more in Kentucky than in some other
places, Kentucky’s PPP-adjusted GDP will be higher than its non-adjusted GDP.

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Chapter 08- The Cost of Living

Problems and Applications

1. Subscribing to the theory that life is indeed a beach, the residents of La Playa spend all of
their money on three things: Every year, they collectively buy 250 bathing suits, 600 tubes of
sunscreen, and 400 beach towels. Using the data in Table 8P-1, calculate the following. [LO 8.1]

a. The total cost of this basket each year from 2013 through 2016.

b. How much the price of this basket has changed from year to year in percentage terms.

Answer:To find the price of each basket, multiply the quantities in the first column by
the corresponding price in each of the other columns and then sum the results. To find
the change in the price of the baskets, simply subtract each year’s sum from the
previous year’s sum. To find the percentage change from year to year, subtract the
current year’s sum from the previous year’s sum, and then divide this amount by the
previous year’s sum. To convert a decimal to a percentage, simply multiply the decimal
by 100.

2. Suppose a typical American consumer purchases three goods, creatively named good A,
good B, and good C. The prices of these goods are listed in Table 8P-2. [LO 8.1]

a. If the typical consumer purchases two units of each good, what was the percentage increase
in the price paid by the consumer for this basket between 2015 and 2016?

b. If the typical consumer purchases 10 units of good B and 2 units of both good A and good C,
what was the percentage increase in the price paid by the consumer for this basket?

c. Given your answers to parts a and b, what is the relationship between the market basket
and the percentage price change?
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Chapter 08- The Cost of Living

Answer:
a. Cost of basket in 2015 = 2($10)) + 2($5) +2($1) = $32.
Cost of basket in 2016 = 2($15) + 2($4) +2($2) = $42.
Prices have increased by ($42 – $32)/$32 = 0.3125, or 31.25%.
b. Cost of basket in 2015 = 2($10) + 10($5) +2($1) = $72.
Cost of basket in 2016 = 2($15) + 10($4) +2($2) = $74.
Prices have increased by ($74 – $72)/$72 = 0.0278, or 2.78%.
c. The overall change in the cost of the market basket is affected by how many units of
each good one purchases. If two goods are rising in price at different rates, but the
market basket contains more of good A than good B, then the rate of increase of the
overall market basket will be closer to the rate of increase of A rather than B. In part a,
the market basket contains the same number of units of each good, so the price changes
are weighted equally. In this case, the rate of inflation is just the average of the
percentage change in the three prices. In part b, the market basket contains more units
of good B, so the large increase in the price of good A does not carry as much weight as
it did in part a. As a result, the inflation rate is much lower.

3. Using the data in Table 8P-3, calculate the CPI in each year, using 2010 as a base year. [LO
8.2]

Answer:CPI in year x = (Cost of basketyear x /Cost of basketbase year) × 100 Inflation rate =
percent change in CPI = [(CPInew – CPIold)/CPIold] × 100

Note: when calculating the inflation rate it is best to use the calculated CPI values and not
the rounded values to avoid rounding error.

Year Price of basket ($) CPI Percent change in CPI

2010 20,000 100 --

2011 21,500 = (21,500/20,000) x 100 = = (107.5 − 100)/100 = 0.075. or

107.5 7.5%

2012 22,800 = (22,800/20,000) x 100 = 114 = (114 − 107.5)/107.5 = 0.060,

or 6.0%

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Chapter 08- The Cost of Living

2013 26,150 = (26,160/20,000) x 100 = = (130.75 − 114)/114 = 0.147,

130.75 or 14.7%

2014 28,825 = (28,825/20,000) x 100 = = (144.125 − 130.75)/130.75 =

144.125 0.102, or 10.2%

2015 32,700 = (32,700/20,000) x 100 = = (163.5 − 144.125)/163.5 =

163.5 0.134, or 13.4%

4. Table 8P-4 lists the prices and quantities consumed of three different goods from 2014–
2016. [LO 8.2]

a. For 2014, 2015, and 2016, determine the amount that a typical consumer pays each year to
purchase the quantities listed in the table.

b. Using the amounts you found in part a, calculate the percentage change in the amount the
consumer paid from 2014 to 2015, and from 2015 to 2016.

c. Why is it problematic to use your answers to part b as a measure of inflation?

d. Suppose we take 2014 as the base year, which implies that the market basket is fixed at the
2014 consumption levels. Using 2014 consumption levels, now find the rate of inflation from
2014 to 2015 and from 2015 to 2016. (Hint: First calculate the cost of the 2014 market basket
using each year's prices and then find the percentage change in the cost of the basket.)

e. Repeat the exercise from part d, now assuming that the base year is 2015.

f. Why were your answers from parts d and e different?

Answer:
a. Multiply the quantity by the price for each good and then sum up for each year.
In 2014, the consumer pays $10(10) + $5(18) + $1(10) = $200.
In 2015, the consumer pays $15(8) + $3(30) + $2(5) = $220.
In 2016, the consumer pays $20(5) + $4(25) + $5(10) = $250.
b. The change between 2014 and 2015 is ($220 – $200)/$200 = 0.1, or 10%.
The change between 2015 and 2016 is ($250 – $220)/$220 = 0.136, or 13.6%.

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Chapter 08- The Cost of Living

c. It is problematic to use your answers to part b as a measure of inflation because the

growth found in part b includes both price changes as well as consumption changes.
d. Using 2014 as the base year, one needs to calculate the price of the market basket in each
year using the quantities in 2014 but the prices for each year.
In 2014, the consumer pays $10(10) + $5(18) + $1(10) = $200.
In 2015, the consumer pays $15(10) + $3(18) + $2(10) = $224.
In 2016, the consumer pays $20(10) + $4(18) + $5(10) = $322.
The change between 2014 and 2015 is ($224 – $200)/$200 = 0.12, or 12%.
The change between 2015 and 2016 is ($322 – $224)/$224 = 0.4375, or 43.75%.
e. Using 2015 as the base year, one needs to calculate the price of the market basket in each
year using the quantities in 2015 but the prices for each year.
In 2014, the consumer pays $10(8) + $5(30) + $1(5) = $235.
In 2015, the consumer pays $15(8) + $3(30) + $2(5) = $220.
In 2016, the consumer pays $20(8) + $4(30) + $5(5) = $305.
The change between 2014 and 2015 is ($220 – $235)/$235 = −0.064, or −6.4%.
The change between 2015 and 2016 is ($305 – $220)/$220 = 0.386, or 38.6%.
f. The answers from parts d and e are different because using 2014 and 2015 as base years
puts different weights on the goods.

5. Which of the following goods have likely required hedonic quality adjustment over time if
they were included in the Consumer Price Index (CPI)[LO 8.3]
a. Laptop computers.
b. Cellphones.
c. Salt.
d. Televisions.
e. Housing.
f. Tennis rackets.

Answer:

A hedonic quality adjustment is required when the features of the good being measured
change over time. The hedonic quality adjustment method removes any price differential
attributed to a change in quality by adding or subtracting the estimated value of that change
from the price of the old item.

a. Yes. Laptop computers have changed over time. Older models were larger, heavier, and
slower to operate.
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Chapter 08- The Cost of Living

b. Yes. More features have been added to cell phones over time, and cell phones now are a
part of every basket. That wasn’t the case when they had spotty reception, cost $4,000, and
were purchased only by high-level executives.

c. No. Salt likely doesn’t need hedonic adjustment; it will always be the same chemical
formula.

d. Yes. The televisions of today are far more complex and offer a far more vivid display than
the TVs of just a decade ago.

e. No. In general, housing in terms of shelter doesn’t need any sort of adjustment. Over
time, the quality of the goods within the house changes, but the housing itself doesn’t
change very much.

f. Yes. Today’s tennis rackets use space-age materials, like carbon fiber and titanium, while
the rackets of yesteryear were made of wood.

6. Use Table 8P-5 to calculate core and headline inflation in each time frame relative to the
base year, assuming that each category is weighted equally in the calculation of headline
inflation.[LO 8.2, 8.4]

a. 2012 to a base year.

b. 2016 to a base year.

c. 2012 to 2016.

Answer:

Headline inflation includes food and energy whereas core inflation does not. Since food and
energy prices are much more volatile than the prices of other goods and services, these
items are removed to get a better measure of what is happening to the prices of other
goods and services.

a. We know the CPI value in the base year is equal to 100.From the base year to 2012:

Core: (102 − 100)/100 = 0.02, or 2%.

Headline: We know core inflation is 2%. The percentage change in the prices of food and
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Chapter 08- The Cost of Living

energy is (120 - 100)/100 = 0.20, or 20%. Since the overall CPI is equally weighted between
the two, we can take an average of the two inflation rates. Headline inflation is therefore
(20% + 2%)/2 = 11%.

b. From the base year to 2016:

Core: (107 − 100)/100 = 0.07, or 7%.
Headline: Core inflation is 7% and the percentage change in the prices of food and energy is
5%. Therefore, headline inflation is (7% + 5%)/2 = 6%.

c. 2012 to 2016:

Core: (107 − 102)/102 = 0.049, or 4.9%.

Headline: 4.9% core and (105 − 120)/120 = -0.125 or −12.5% food and energy.
Weight: 50/50, so the average of the two = [4.9% + (−12.5%)]/2 = −3.8%.

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Chapter 08- The Cost of Living

7. Table 8P-6 shows the GDP deflator and CPI over five recent years. How much did prices
change between years in each measure?By what percent did prices change between years for
each measure? Calculate the annual inflation rate and then the inflation rate across the entire
time period.[LO 8.4]

Answer:Percent change in CPI = (CPInew – CPIold)/CPIold. The same equation holds for the GDP
deflator.

Year GDP Change in GDP deflator CPI Change in CPI

deflator

2012 100 - 100 -

2013 105 (105 − 100)/100 = 0.05, 104 (104 − 100)/100 = 0.04,

or 5% or 4%

2014 112 (112 − 105)/105 = 0.067, 110 (110 − 104)/104 = 0.057,

or 6.7% or 5.7%

2015 123 (123 − 112)/112 = 0.098, 113 (113 − 110)/110 = 0.027,

or 9.8% or 2.7%

2016 127 (127 − 123)/123 = 0.033, 120 (120 − 113)/113 = 0.062,

or 3.3% or 6.2%

2012-2016 - (127 − 100)/100 = 0.27, - (120 − 100)/100 = 0.20,

or 27% or 20%

8. The median American household earned $9,387 in 1973 and $53,657 in 2014. During that
time, though, the CPI rose from 44.4 to 236.7.[LO 8.5]
a. Calculate the total growth rate in nominal median household income from 1973 to 2014.
b. Calculate the total growth rate in real median household income from 1973 to 2014.

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Chapter 08- The Cost of Living

Answer: It is worth noting that these are the real numbers from the U.S. Census. The fact
that the median household has experienced almost no real income growth over the past 40
years is a primary concern for modern macroeconomists.
a. Nominal growth rate = (53,657 – 9,387)/9,387 = 4.716, or 471.6%.
b. First one needs to calculate the real income in 1973 and 2014 in 2014 dollars.
1973real2014 = 1973nominal × (CPI2014/CPI1973) = 9,387 × (236.7/44.4) = 50,043.
Real income in 2014 in 2014 dollars is by definition the same as nominal income.
Alternatively, it may help to see the numbers:
2014real2014 = 2014nominal × (CPI2014/CPI2014) = 53,657 × (236.7/236.7) = 53,657.
Next one needs to calculate the increase in real income.
Real growth rate = (53,657 – 50,043)/50,043 = 0.072, or 7.2%.

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Chapter 08- The Cost of Living

9. Using Table 8P-7, find the real value of a $1,000 payment to be received each year given the
following CPI values. Next, find the amount that this $1,000 should be adjusted to, in order to
keep its real value at $1,000.[LO 8.5, LO 8.6]

Answer: To find the purchasing power of $1,000 in various years, use the equation from the
chapter and calculate the real values in 2013 dollars.

Example: Value of $1,000 received in 2014 in 2013 dollars: 2014real2013 = 2014nominal ×

(CPI2013/CPI2014)

Use 2013 as the base year. To find the cost of living adjusted payment, one simply needs to
increase the payment at the same rate as the CPI. This can be done by multiplying the
original $1,000 payment by the current year CPI and then dividing by the original year
(2013) CPI.

Year CPI Real value of $1,000 (in $2005) Cost of living

adjusted payment

2013 100 2005real2005 = 2005nominal x (CPI2005/CPI2005) = =1,000 x (CPI2005/CPI2005) =

1,000 x (100/100) = $1,000 1,000 x (100/100) = $1,000

2014 103 2006real2005 = 2006nominal x (CPI2005/CPI2006) = =1,000 x (CPI2006/CPI2005) =

1,000 x (100/103) = $970.87 1,000 x (103/100) = $1,030

2015 105 2007real2005 = 2007nominal x (CPI2005/CPI2007) = =1,000 x (CPI2007/CPI2005) =

1,000 x (100/105) = $952.38 1,000 x (105/100) = $1,050

2016 110 2008real2005 = 2008nominal x (CPI2005/CPI2008) = =1,000 x (CPI2008/CPI2005) =

1,000 x (100/110) = $909.09 1,000 x (110/100) = $1,100

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Chapter 08- The Cost of Living

10. Suppose General Electric paid its line workers $10 per hour in 2015 when the Consumer
Price Index was 100. Suppose that deflation occurred and the aggregate price level fell to 80 in
2016 [LO 8.5, LO 8.6]
a. What must GE pay its workers in 2016 in order to keep the real wage fixed?
b. What did GE need to pay its workers in 2016 if it wanted to increase the real wage by 10
percent?
c. If GE kept the wage fixed at $10 per hour in 2016, in real terms, what percentage increase in
real wages did its workers get?

Answer:
a. We need the real hourly wage in 2016 measured in 2015 dollars to be equal to $10.
The equation is 2016real2015 = 2016nominal × (CPI2015/CPI2016) = $10.
Plugging in the CPIs, we get $10 = 2016nominal × (100/80).
Multiplying both sides by (80/100), we get $8 = 2016nominal.

b. GE needed to pay its workers 10 percent more than the answer in part a, or $8.80 per
hour (= $8 × 1.1).

c. First, we need to find out what the real wage was in 2016 in 2015 dollars.
The equation is 2016real2015 = 2016nominal × (CPI2015/CPI2016), so 2016real2015 = $10 × (100/80) =
$12.50.
The real wage in 2015 measured in 2015 dollars is the same as the nominal wage by
definition.
Alternatively, it may help to see the numbers: 2015real2015 = 2015nominal × (CPI2015/CPI2015) = $10
× (100/100) = $10.
Next, we need to calculate the increase in real wages.
Real growth rate = ($12.50 – $10)/$10 = 0.25, or 25%.

11. Table 8P-8 shows the prices of a tall Starbucks latte in countries around the world. Using the
data, and the fact that a latte costs $3 in the United States, calculate how much a country’s
currency is under- or overvalued according to purchasing power. First, calculate the implied
exchange rate for each country. Next, calculate the "latte index" for each country using the Big
Mac index formula from the chapter.[LO 8.7]

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Chapter 08- The Cost of Living

Answer: The first step is to calculate what the exchange rate would have to be if the theory
of purchasing power parity holds true. To do this, we divide the cost of a latte in the foreign
currency by the cost of the latte in the United States. Next, we use the equation from the
“Big Mac Index” from the chapter = [(PPP implied exchange rate – official exchange
rate)/official exchange rate] × 100.

Country Price Official Implied exchange rate Cost of US latte

exchange rate if PPP holds

Thailand 60 baht 30 baht/$ 60/3 = 20 baht/$ (20 − 30) x 100/30 = −33.3%

Argentina 15 pesos 6 pesos/$ 15/3 = 5 pesos/$ (5 − 6) x 100/6 = −16.7%

U.K. 2 pounds 0.5 pounds/$ 2/3 = .67 pounds/$ (0.67 − 0.5) x 100/0.5 = 34.0%

Japan 450 yen 80 yen/$ 450/3 = 150 yen/$ (150 − 80) x 100/80 = 87.5%

12. An employee asks her boss whether she can transfer offices so that she can work in a
different part of the country. The boss responds positively and says that the employee can
choose to work in Cleveland, Miami, or New York City. The boss then hands the employee a list,
as shown in Table 8P-9, of the salaries that she would earn in the different cities and the
average price levels in those same cities[LO 8.7, 8.8]

a. From a standpoint of maximizing the employee’s consumption possibilities, which office

should she choose?

b. What would be the minimum salary in New York City the boss could offer the employee to
make the employee indifferent between moving to Cleveland and to New York City?

Answer:
a. We cannot just compare the salaries in the three locations directly because the price
levels are different. We need to calculate the real salary in each location and we will choose
to do this by adjusting all salaries to Cleveland dollars. Using the equation from the chapter:

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Chapter 08- The Cost of Living

1969real2009 = 1969nominal × (CPI2009/CPI1969),

switch 1969 for New York City or Miami and 2009 for Cleveland.
Now the value of New York City income in Cleveland dollars is NYCrealCleveland = NYCnominal ×
(CPICleveland/CPINYC).
Cleveland = 80,000 × (100/100) = $80,000.
Miami = 120,000 × (100/155) = $77,419.
New York City = 150,000 × (100/210) = $71,429.
The employee makes the most money in Cleveland after adjusting for the cost of living.

b. The manager needs to offer a nominal salary in New York City such that the real salary in
“Cleveland dollars” is at least $80,000. Using the equation from part a:

NYCrealCleveland = NYCnominal × (CPICleveland/CPINYC).

Substitute in $80,000 for NYCrealCleveland and solve for NYCnominal.
$80,000 = NYCnominal × (100/210).
Multiplying each side by 210/100 yields $168,000 = NYCnominal.

13. Calculate the PPP-adjusted GDP for each of four countries, using the information found in
Table 8P-10. [LO 8.6]

Answer: Using the equation in the text for PPP adjustment, we find that:PPP-adjusted GDP =
GDPnominal x [1/(100% + purchasing power index)].

Country GDP Price-level PPP-adjusted GDP

comparison

Ona $10,000 6% =10,000 x [1/(1 + 0.06)] = 10,000 x 1/1.06 =

$9,434

Rye $12,700 −27% =12,700 x [1/(1 – 0.27)] = 12,700 x 1/0.73 =

$17,397

Zolfo $14,100 −10% =14,100 x [1/(1 – 0.10)] = 14,100 x 1/0.9 =

$15,667

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Education.
Chapter 08- The Cost of Living

Avon $23,400 20% =23,400 x [1/(1 + 0.20)] = 23,400 x 1/1.20 =

$19,500

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