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Practical # 6 Help Sheet Definition of nominal price: The nominal price of an item is the sticker price of the item. It is the price that is paid in dollars for an item. Definition of real price: The real

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Practical # 6 Help Sheet Definition of nominal price: The nominal price of an item is the sticker price of the item. It is the price that is paid in dollars for an item. Definition of real price: The real price of an item is the quantity of other goods that must be sacrificed to purchase the item. For example, if the money used to purchase an item will also purchase 6 units of other goods, the item s real price is 6 units. In making economic decisions, real prices are preferred to nominal prices since they reflect the opportunity cost of purchasing one good over another. That is, if the real price of an item is 6 units, you know that you must forfeit 6 units of other goods to purchase the item. If the item is worth less to you than 6 units of other goods, you should not purchase it. If you were given the item s nominal price, say $150, you would not know the number of units of other goods that must be forfeited to purchase the item so a purchasing decision is more difficult. The point is that people are interested in what they can purchase with their money, not in the number of dollars that they have in the bank. If you do not believe this statement, consider the option of having an income of $1,000 when the price of an item is $50 or an income of $2,000 when the price of the item is $125. Which situation would you prefer? Since 20 items can be purchased in the first situation and only 16 items can be purchased in the second situation, I would rather have an income of $1,000. How to calculate the percent change in prices: To calculate the percent change in prices from year x to year y: {( y price - x price) / x price} X 100 Answer (given with a % sign). Note: The year y price is the most current price, while the year x price is the earliest price. For example, year y may be 1994 while year x is See the Practical #2 Help Sheet for examples and additional information on calculating percent changes. 2 How to calculate the inflation rate: The rate of inflation between year x and year y is % Δ {(year y's - year x's ) / year x's } * 100 where year y is the most current year, while year x is the earliest year. is an abbreviation for the Consumer Price Index, which is an average of the prices of various goods and services purchased by families. The base year of the is given a value of 100 (Current base year is 1982 to ). If prices in one period are 25% higher than in the base year, that period will have a value of (25% * 100) 125. If the index is 89 for a period, prices in that period are 89% of prices in the base period. How to calculate relative prices: Suppose that you are asked to calculate the 1974 relative price, which is the price that an item purchased in 1974 would have been in the base period if the item's price had increased at the rate of inflation from 1974 to the base period: 1974 Relative Price (1974 Nominal Price / 1974 Value) * 100. Suppose that you are asked to calculate the 1993 relative price, which is the price that an item purchased in 1993 would have been in the base period if the item's price had increased at the rate of inflation from the base period to 1993: 1993 Relative Price (1993 Nominal Price / 1993 Value) * 100. How to determine if there has been a real price increase or decrease: There are two ways to determine the change in the real price of an item: Method 1: This method uses relative prices. Suppose that you are asked to compare an item s nominal prices in 1974 and First you must convert the nominal prices to relative prices. If the 1993 relative price is greater than the 1974 relative price, the item's price had to have increased at a rate greater than the inflation rate sometime between 1974 and In this case, there has been a real price increase. If the 1993 relative price is less than the 1974 relative price, the item's price had to have increased at a rate less than the inflation rate sometime between 1974 and In this case, there has been a real price decrease. In general, if you are comparing the relative prices, and the relative price of the most current year is greater than the relative price of the earliest year, there has been a real price increase. 3 If the relative price of the most current year is less than the relative price of the earliest year, there has been a real price decrease. Remember: Latest year has the largest relative price real price increase. Latest year has the smallest relative price real price decrease. Method 2: This method compares the inflation rate between two years with the percent change in nominal prices over the two years. Inflation rate Percent change in nominal prices real price increase. Inflation rate Percent change in nominal prices real price decrease. Problems: 1. The real price of an item is 8 units of other goods. You place a value of 12 units of other goods on the item. Should you purchase the item? Price of the item Value of the item Purchase the item. 2. Item one has a real price of 4 units of other goods, and item two has a real price of 14 units of other goods. Which good has the highest price? 14 4 item two has the highest price. 3. Would you rather have an income of $24,000 when the average price is $25 or an income of $40,000 when the average price is $50? $24,000 / $ goods. Prefer an income of $24,000. $40,000 / $ goods. 4. Price $1.25 $1.32 $1.15 $1.05 $.99 $1.00 a) Calculate the percent change in prices from 1988 to 1991: {(1991 price price) / 1988 price} * 100 ($ $1.25) / $1.25) * % b) Calculate the percentage change in prices between 1989 and 1993: {(1993 price price) / 1989 price} * 100 {($ $1.32) / $1.32} * % c) Calculate the percentage change in prices between 1988 and 1989: {(1989 price price) / 1988 price} * 100 {($ $1.25) / $1.25} * % 5. The 1967 is How much lower were prices in 1967 than in the base period? % lower. 6. The 1990 is 124. How much higher were prices in 1990 than in the base period? % higher. 7. What was the inflation rate from 1960 to 1993? {( ) / 1960 } * 100 {( ) / 29.6} * % What was the inflation rate from 1981 to 1990? {( ) / 1981 } * 100 {( ) / 90.9} * % What was the inflation rate from 1992 to 1993? {( ) / 1992 } * 100 {( ) / 140.3} * %. 10. Nominal Price $10.00 $13.50 $23.65 a) What is the 1960 relative price? 1960 Relative Price (1960 Nominal Price / 1960 Value) * 100 ($10.00 / 29.6) * 100 $33.78 b) What is the 1970 relative price? 1970 Relative Price (1970 Nominal Price / 1970 Value) * 100 ($13.50 / 38.8) * 100 $34.79 c) What happened to real prices between 1960 and 1970 (use relative prices)? 1970 Relative Price ($34.79) 1960 Relative Price ($33.78) Real prices increased. d) What is the 1980 relative price? 1980 Relative Price (1980 Nominal Price / 1980 Value) * 100 ($23.65 / 82.4) * 100 $28.70 e) What happened to real prices between 1970 and 1980 (use relative prices)? 1980 Relative Price ($28.70) 1970 Relative Price ($34.79) Real prices decreased. f) What was the inflation rate from 1960 to 1970? {( ) / 1960 } * 100 % {( ) / 29.6} * %. g) What was the percent change in nominal prices from 1960 to 1970? {(1970 price price) / 1960 price} * 100 7 {($ $10.00) / $10.00} * % h) What happened to real prices between 1960 and 1970 (use % Δ in prices)? Inflation Rate (31.1 %) % Δ in Prices (35 %) Real prices increased. i) What was the inflation rate from 1970 to 1980? {( ) / 1970 ) * 100 {( ) / 38.8) * %. j) What was the percent change in nominal prices from 1970 to 1980? {(1980 price price) / 1970 price) * 100 {($ $13.50) / $13.50) * % k) What happened to real prices between 1970 and 1980 (use % Δ in prices)? In flation Rate (112.4 %) % Δ in Prices (75.2 %) Real prices decreased.

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