topic3_consumer behaviorII

Topic3_consumer behaviorII

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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...
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This document was uploaded on 03/16/2014 for the course ECONOMICS 106 at Oxford University.

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