ECO402 Assignment No 01 Discussion and Solution Last Date 2nd December 2014
Continuous rise in prices of food and non food items from last few years is most important concern for majority people in Pakistan. Higher prices have made people’s lives more difficult. They are unable to afford the same standard of living which they were getting in past. To calculate and analyze rise in cost of living, we have taken the basket of two persons, Ali and Atif belonging to middle class in different periods. Selected Basket contains food and non food items. Both persons have same preferences and are getting same satisfaction. Ali is doing spending on food and non food items in year 2011 and Atif is spending his income on these items in year 2013. Atif has to bear more cost as compared to Ali if he gets the same satisfaction/standard of living which Ali is getting in year 2011. Items, quantities and their prices in 2011 and 2013 are given below. Price (Rs.) Units purchased Items 2011 2013 Ali Atif Food Items 80 95 10 28 Non-Food Items 55 130 32 12 Using the given data, you are required to: a) Calculate cost of basket/expenditures of Ali in year 2011. b) Calculate cost of basket/expenditures of Atif in year 2013. c) How much adjustment in ideal cost of living is required by Atif to attain the same level of utility which Ali is getting? d) Calculate ideal cost of living index. e) Graphically compare the costs of basket/expenditures borne by Ali and Atif to attain same utility. Note: Write down all relevant steps involved in calculation. Marks: (2.5+2.5+3+4+3
Consumer price index (CPI) and cost-of-living adjustment (COLA)
§ Cost-of-Living Index: ratio of the present cost of a typical bundle of consumer goods and
services compared with the cost during a base period.
Example:
Two sisters, A and B whose preferences are identical. Person A and B began their university
education in 1990 and 2000 respectively.
Person A in 1990
- Her parents gave $500 for to A to spend on food and books
- Price of food = $2, and Price of book is $20
- A’s consumption: 100 food and 15 books
ð
I1 = $2´100 + $20´15 = $500
Person B in 2000
- Price of food = $2.2, and price of book is $100
- Her parents decided to give B the amount which is equivalent in buying power to the
budget given to A. How much would be the budget?
- B’s consumption: 300 food and 6 books (same utility level as A’s bundle and B
consumes more food and less books after the price change)
ð
I 2 = $2.2´300 + $100´6 = $1260
§ The ideal cost of living index: the cost of attaining a given level of utility at current
prices relative to the cost of attaining the same utility at base prices
ð In this example, ideal cost of living index: $1260/$500 = 2.52 (152% in the cost of
living)
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