This preview shows page 1. Sign up to view the full content.
Unformatted text preview: d average of price changes, weights budget share
32 Calculating Inflation Indexes (Cont
Calculating Inflation Indexes (Cont.)
Y1 p1 x1
x p1 y1
y • Cost in period 1 (base year):
(b
2
2
Y2 px x1 p y y1
• Cost in period 2:
• CPI requires same bundle x1 , y1 is consumed. CPI Where 2
px x1 Y2
Y1 2
p y y1 Y1
x p1 x1 Y1
x budget share of x 2
py 2
px 1
px x1
1
px p1
y p1 y1
y Y1 and
and y p1 y1 Y1
y budget share of y 33 • Effect of CPI adjustment
Good y
Ia/PY2 I/PY1
I/PY2 B A U1
U2
I / PX2 Ia / PX2 I / PX1 Good x
34 • True Cost of Living adjustment
Good y
Ia/PY2
I/PY1
I/PY2 B A U1
U2
I / PX2 Ia / PX2 I / PX1 Good x
35 True Cost of Living Adjustment
True Cost of Living Adjustment
• True cost of living index an inflation index
that holds utility constant over time
• Question: how big an increase in income
bi
would leave him exactly as well off in the
second year as in the first? 36 CPI Substitution Bias
CPI Substitution Bias
• Inflation is more accurately captured by True
Cost of Living index.
– CPI is an alternative which is easier to calculate.
– Income adjustments based on CPI suffer from an
upward bias. • substitution bias – it ignores that consumers
may sub...
View
Full
Document
This document was uploaded on 03/16/2014 for the course ECONOMICS 106 at Oxford University.
 Spring '13
 PaulRuud
 Microeconomics, Econometrics

Click to edit the document details