Consider a simple economy where the basket of goods used to calculate the CPI contains two items: shirts and pants. The basket consists of 3 shirts and 2 pairs of pants. Each item increases in price by $1 in year 2. The pants price is 20$ and the shirt price is 25$. What is the CPI for year 2.

The CPI for year 2 is 1.04

Step-by-step explanation:

CPI is given by current price of items : old price of items

CPI for year 2 = Total price of items in year 2 : Total price of items in year 1

The basket consists of 3 shirts and 2 pairs of pants

Total price of items in year 1 = (3 * $25) + (2 * $20) = $75 + $40 = $115

In year 2, price increases by $1

Total price of e in year 2 = (3 * $26) + (2 * $21) = $78 + $42 = $120

CPI for year 2 = $120/$115 = 1.04