Econ Unit 2 - Friday 10:40 AM Measuring the cost of living Inflation is a persistent increase in the economy's overall price level o Not only a few

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2/25/2008 Friday, February 22, 2008 10:40 AM Measuring the cost of living Inflation is a persistent increase in the economy's overall price level o Not only a few prices o Not just for a single period The inflation rate is the percentage change in the price level from the previous period The Consumer Price Index The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer The Bureau of Labor Statistics reports the CPI each month It is used to monitor changes in the cost of living over time Changes in the CPI When the CPI rises, the typical family has to spend more dollars to maintain the same standard of living (less purchasing power) How the Consumer Price Index is calculated 1. Fix the basket . Determine what prices are most important to the typical consumer o The Bureau of Labor Statistics (BLS) identifies a market basket of goods and services the typical consumer buys o The BLS conducts monthly consumer surveys to set the weights for the prices of those goods and services 2. Find the Prices . Find the prices of each of the goods and services in the basket for each point in time 3. Compute the basket's cost . Use the data on prices to calculate the cost of the basket of goods and services at different times. 4. Choose a base year and compute the index o Designate one year as the base year o Compute the index by using this formula: 5. Compute the inflation rate. Calculating the Consumer Price Index and the inflation Rate: Another Example o Base year is 2002
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o Basket of Goods in 2002 costs $1200 o The same basket in 2004 costs $1236 o CPI = ($1236/$1200) x 100 = 103 o Percentage change in 2004 is 3% What is in the CPI's basket? o 42% Housing o 17% Transportation o 15% Food and Beverage o 6% Education and Communication o 6% Medical care o 6% Recreation o 4% Apparel o 4% Other goods and services Problems in Measuring the Cost of Living The CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living Substitution Bias o The basket does not change the reflect consumer reaction to changes in relative prices Consumers substitute toward goods that have become relatively less expensive The index overstates the increase in cost of living by not considering consumer substitution Introduction of New Goods o The basket does not reflect the change in purchasing power brought on by the introduction of new products o New products result in greater variety, which in turn makes each dollar more valuable o Consumers need fewer dollars to maintain any given standard of living CPI = (Price of basket of goods and services) X 100 (Price of basket in base year) Inf. Rate in Year 2. = CPI in Year 2 - CPI in Year 1 X 100
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CPI in Year 1 2/27/2008 Wednesday, February 27, 2008 8:02 AM Problems in measuring the cost of living o Unmeasured quality changes
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This note was uploaded on 04/10/2008 for the course ECON 1015 taught by Professor Myounglee during the Spring '08 term at Missouri (Mizzou).

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Econ Unit 2 - Friday 10:40 AM Measuring the cost of living Inflation is a persistent increase in the economy's overall price level o Not only a few

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