(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 125

100 PART 2 • Producers, Consumers, and Competitive Markets

F IGURE 3.23

COMPARING GASOLINE RATIONING TO THE FREE MARKET
Some consumers will be worse off, but others may be better off with rationing. With
rationing and a gasoline price of $1.00 she
buys the maximum allowable 2000 gallons
per year, putting her on indifference curve
U1. Had the competitive market price been
$2.00 per gallon with no rationing, she
would have chosen point F, which lies below indifference curve U1. However, had the
price of gasoline been only $1.33 per gallon, she would have chosen point G, which
lies above indifference curve U1.

Spending
on other
goods ($) 20,000
D

G
14,000

F

U1

0

3000

10,000

15,000

20,000

Gasoline (gallons per year)

In §1.3, we introduced the
Consumer Price Index as
a measure of the cost of a
“typical” consumer’s entire
market basket. As such,
changes in the CPI also measure the rate of inflation.
• 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.

In §1.3, we explained that
the Producer Price Index
provides a measure of the
aggregate price level for
intermediate products and
wholesale goods.

would choose point F, which lies below indifference curve U1. (At point F, she
purchases 3,000 gallons of gasoline and has $14,000 to spend on other goods.)
But, consider what would happen if the price of gasoline were only $1.33 per

gallon. Then the relevant budget line would be the line associated with a maximum gasoline consumption of about 15,000 gallons per year ($20,000/$1.33).
She would choose a point such as G, where she purchases more than 3,000
galls of gasoline and has more than $14,000 to spend on other goods. In this
case, she would be better off without rationing, since point G lies above indifference curve U1. We can conclude, therefore, that while rationing is a less
efficient means of allocating goods and serves, under any particular rationing
scheme some individuals may well be better off, even though others will necessarily be worse off.

*3.6 Cost-of-Living Indexes
The Social Security system has been the subject of heated debate for some time
now. Under the present system, a retired person receives an annual benefit
that is initially determined at the time of retirement and is based on his or
her work history. The benefit then increases from year to year at a rate equal
to the rate of increase of the Consumer Price Index (CPI). Does the CPI accurately reflect the cost of living for retirees? Is it appropriate to use the CPI
as we now do—as a cost-of-living index for other government programs, for
private union pensions, and for private wage agreements? On a similar note,
we might ask whether the Producer Price Index (PPI) accurately measures the
change over time in the cost of production. The answers to these questions lie
in the economic theory of consumer behavior. In this section, we describe the
theoretical underpinnings of cost indexes such as the CPI, using an example
that describes the hypothetical price changes that students and their parents
might face.