Chapter 11 Measuring the Cost of Living

# Chapter 11 Measuring the Cost of Living - Chapter 11...

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Chapter 11 Measuring the Cost of Living The Consumer Price Index - a measure of the overall cost of the goods and services bought by a typical consumer. How to compute CPI 1. Determine which prices are most important to the consumer (the basket is fixed, g&s is fixed) 2. Find the prices. 3. Compute the cost 4. Choose Base year and compute the CPI Price of basket of goods and services in current year CPI = -------------------------------------------------- x100 Price of basket in the base year 5. Compute the inflation rate CPI in year 2 - CPI in year 1 Inflation rate in year 2= -------------------------------- x 100 CPI in year 1 Producer Price Index (PPI) = a measure of the cost of a basket of goods and services bought by firms. Problems in measuring the cost of living 1. Substitution bias =Some prices rise more than others, consumers respond by buying less of the good whose prices have risen and by buying more of the goods whose price risen less or fallen. The fixed basket is no longer accurate.

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Chapter 11 Measuring the Cost of Living - Chapter 11...

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