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Unformatted text preview: Chapter 16 Measuring the Cost of Living Lectures Supratim Das Gupta/Joe Dance Key Questions to Address: • What is the Consumer Price Index(CPI)? How is it calculated? What is it used for? • How does the CPI differ from the GDP deflator? • How can we correct interest rates for inflation? Consumer Price Index(CPI) • CPI is a measure of the overall cost of the goods and services bought by a typical consumer • Measures the typical consumer’s cost of living • The basis of Cost of Living Adjustments (COLA’s) in many contracts and in Social Security MEASURING THE COST OF LIVING 4 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 5 How the CPI Is Calculated 1. Choose a base year and compute the index. The CPI in any year equals 1. Compute the inflation rate. The percentage change in the CPI from the preceding period. 100 x cost of basket in current year cost of basket in base year CPI this year – CPI last year CPI last year Inflation rate x 100% = MEASURING THE COST OF LIVING 6 EXAMPLE basket: {4 pizzas, 10 lattes} $12 x 4 + $3 x 10 = $78 $11 x 4 + $2.5 x 10 = $69 $10 x 4 + $2 x 10 = $60 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: 100 x ($60/$60) = 100 2008: 100 x ($69/$60) = 115 2009: 100 x ($78/$60) = 130 Inflation rate: 15% 115 – 100 100 x 100% = 13% 130 – 115 115 x 100% = (Base:2007) A C T I V E L E A R N I N G A C T I V E L E A R N I N G 1 1 Calculat Calculat e the CPI e the CPI 7 CPI basket: {10 lbs beef, 20 lbs chicken} The CPI basket cost $120 in 2004, the base year. A. Compute the CPI in 2005. B. What was the CPI inflation rate from 20052006? price of beef price of chicken 2004 $4 $4 2005 $5 $5 2006 $9 $6 A C T I V E L E A R N I N G A C T I V E L E A R N I N G 1 1 Answers Answers 8 A. Compute the CPI in 2005: Cost of CPI basket in 2005 = ($5 x 10) + ($5 x 20) = $150 CPI in 2005 = 100 x ($150/$120) = 125 CPI basket: {10 lbs beef, 20 lbs chicken} The CPI basket cost $120 in 2004, the base year....
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This note was uploaded on 06/03/2011 for the course ECON 224 taught by Professor Ozturk during the Fall '09 term at South Carolina.
 Fall '09
 OZTURK
 Inflation

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