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17.Measuring the Cost of Living

# 17.Measuring the Cost of Living - ECO108/Spring 2011...

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ECO108 /Spring 2011 Instructor: Jieruo Liu Lecture17. Measuring the Cost of Living (Mankiw, chapter 16) The Consumer Price Index (CPI): o It measures the typical consumer’s cost of living How the CPI Is Calculated? o Three Steps: 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. 4. Choose a base year and compute the index: The CPI in any year equals 100 x (cost of basket in current year/ cost of basket in base year) 5. Compute the inflation rate: The percentage change in the CPI from the preceding period: Inflation rate = (CPI last year CPI this year)/CPI last year *100%

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ECO108 /Spring 2011 Instructor: Jieruo Liu Problems with the CPI: o Substitution Bias: Over time, some prices rise faster than others. Consumers substitute toward goods that become relatively cheaper. The CPI misses this
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