EC 151 Ch 11 - EC 151 Ch 11 Measuring the cost of living...

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Unformatted text preview: EC 151 Ch: 11 Measuring the cost of living The CPI Correcting economic variables for the effects of inflation Measuring the cost of living Why measure the cost of living? GDP examined the Q of goods and services the Economy is producing We'll look at how economists measure the cost of living Need to convert dollars into measure of purchasing power CPI Inflation rate The Consumer Price Index CPI a measure of the overall cost of the goods and services bought by a typical consumer fix the basket find prices compute the basket's cost choose a base year and compute the index compute the inflation rate How the CPI is calculated The Consumer Price Index Compute the index: Inflation rate CPI = { (cost of basket in current year) } * 100 (cost of basket in base year) the % change in the P index from preceding period Inflation rate = { (CPI y2 CPI y1) } * 100 ( CPI y1) a measure of the cost of a basket of goods and services bought by firms Producer price index What is in CPI's basket Problems in measuring the cost of living Substitution bias Introduction of new goods Unmeasured quality change GDP deflator vs. CPI GDP deflator reflects the prices of all goods produced domestically prices of goods currently produced compared to base year CPI reflects the prices of goods bought by consumers prices fixed basket over time GDP deflator vs. CPI Correcting dollar figures for inflation Correcting economic variables for inflation value in y2 $ = value of y1 $ * (P level y2 / P level y1) example Case study: Mr. Index Goes to Hollywood Indexation Indexation the automatic correction of a dollar amount for the effects of inflation by law or contract government transfer programs tax brackets unions labor contracts Real and Nominal interest rates Nominal interest rate Real interest rate real I = nominal I inflation rate CPI, more information ...
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