9 Consumers substitute toward goods that have become relatively less expensive

9 consumers substitute toward goods that have become

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9 Consumers substitute toward goods that have become relatively less expensive. 9 The index overstates the increase in cost of living by not considering consumer substitution. ECW1102, Semester 1, 2017 MUM/ Dr. Shahriar Kabir
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21 Problems in Measuring the Cost of Living Introduction of New Goods The introduction of new goods increases variety, allows consumers to find products that meet their needs. In effect, dollars become more valuable. The CPI misses this effect because it uses a fixed basket of goods. ECW1102, Semester 1, 2017 MUM/ Dr. Shahriar Kabir
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22 Problems in Measuring the Cost of Living Unmeasured Quality Changes If the quality of a good rises from one year to the next, the value of money rises, even if the price of the good stays the same. If the quality of a good falls from one year to the next, the value of money falls, even if the price of the good stays the same. The statistical department tries to account for quality changes, but quality is hard to measure. ECW1102, Semester 1, 2017 MUM/ Dr. Shahriar Kabir
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23 Problems in Measuring the Cost of Living Each of these problems causes the CPI to overstate the increases in cost of living. The statistical department has made technical adjustments, but CPI probably still overstates inflation by app. 0.5% p.a. This is important because Social Security payments and many contracts have COLAs (Cost of Living Adjustments) tied to the CPI. ECW1102, Semester 1, 2017 MUM/ Dr. Shahriar Kabir
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24 CPI vs. GDP Deflator ECW1102, Semester 1, 2017 MUM/ Dr. Shahriar Kabir
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25 CPI GDP deflator CPI reflects the prices of a basket of g&s purchased by consumers only GDP deflator reflects the prices of all g&s produced in the economy Imported goods included in CPI as bought by consumers Imported goods excluded from GDP deflator as not produced domestically CPI compares a fixed basket of goods ( base year production ) GDP deflator compares the prices of currently produced goods to the prices of the same goods in the base year Fixed basket (but modified every 4 or 5 years). (problems of substitution bias, introduction of new goods & unmeasured quality changes) Changing basket, reflects current year production ECW1102, Semester 1, 2017 MUM/ Dr. Shahriar Kabir
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26 Figure 2 Two Measures of Inflation (Malaysia: 1950-2007) -5 0 5 10 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Percent per Year CPI GDP deflator ECW1102, Semester 1, 2017 MUM/ Dr. Shahriar Kabir
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27 Correcting Variables for Inflation ECW1102, Semester 1, 2017 MUM/ Dr. Shahriar Kabir
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28 George Best vs. Ryan Giggs Earning/week in 1968 = 150 pound (240 USD) Earning/week in 2011 = 75,000 pound (120,000 USD) Admission price in 1968 = 1 USD George Best (1961-1984) Ryan Giggs (1990-2014) Admission price in 2011 = 51-86 USD WHO HAD A BETTER LIFE? ECW1102, Semester 1, 2017 MUM/ Dr. Shahriar Kabir
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29 Price level in 1968 $240 $ x 116.4 8.6 3,248. Correcting Variables for Inflation: Comparing Dollar Figures from Different Times Price level in 2011 1968 x Salary Salary 2011 Inflation makes it harder to compare dollar from different times.
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