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Chapter 6

# Chapter 6 - Chapter 6 Measuring the cost of Living...

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Chapter 6 – Measuring the cost of Living Inflation – measures the % change in the aggregate price level in the economy. How is the aggregate price level measured? Price Index: measures cot of purchasing a given market basket in a given year relative to the base year. 3 Price Indices: 1. 2. 3. ___________________________ Formula: Price Index = Consumer Price Index ( CPI) – Measures the price of a basket of goods consumed by a “typical” household. measures the typical consumer’s cost of living the basis of cost of living adjustments (COLAs) in many contracts and in Social Security MEASURING THE COST OF LIVING 9 What’s in the CPI’s Basket? 43% 17% 15% 6% 6% 6% 4% 3% Housing Transportation Food & Beverages Medical care Recreation Education and communication Apparel Other

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MEASURING THE COST OF LIVING 3 How the CPI Is Calculated 1. Fix the “basket.” The Bureau of Labor Statistics (BLS) surveys consumers to determine what’s in the typical consumer’s “shopping basket.” 2. Find the prices. The BLS collects data on the prices of all the goods in the basket. 3. Compute the basket’s cost. Use the prices to compute the total cost of the basket. MEASURING THE COST OF LIVING 4 How the CPI Is Calculated 4. Choose a base year and compute the index. The CPI in any year equals 5. Compute the inflation rate. The percentage change in the CPI from the preceding period. 100 x cost of basket in ______year cost of basket in _____year CPI this year CPI last year CPI last year Inflation rate x 100% =
MEASURING THE COST OF LIVING 5 EXAMPLE basket: {4 pizzas, 10 lattes} \$__x 4 + \$__x 10 = \$ \$__ x4 + \$__ x 10 = \$ \$__ x4 + \$__ x10 = \$ cost of basket \$3.00 \$2.50 \$2.00 price of latte \$12 2009 \$11 2008 \$10 2007 price of pizza year Compute CPI in each year 2007 as the base year 2007: 100 x (\$___/\$___) = 2008: 100 x (\$___/\$___) = 2009: 100 x (\$___/\$___) = __% _____ ___ ___ x 100% = __% _____ ___ ____ x 100% = Using Inflation Rate Problems in Measuring the Cost of Living 1. Substitution Bias

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Chapter 6 - Chapter 6 Measuring the cost of Living...

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