Transcript lect12

Measuring the Cost of Living
Professor Chris Adam
Australian Graduate School of Management
University of Sydney and University of New
South Wales
1
INTRODUCTION
• How to compare dollar-based data from
one period to another?
• Use of index numbers
– Consumer Price Index
– GDP Deflator
– Real interest rates
– Real exchange rates
2
CONSUMER PRICE
INDEX
• Measure of overall cost of goods and
services bought by typical consumer
• Monthly measure based on “basket” of
consumption goods and services
• Selection of basket content, appropriate
prices, and base year
• Inflation rate calculation
• Producer Price Index
3
INFLATION
4
PROBLEMS IN COL
MEASUREMENT
• Substitution bias
– If price changes not uniform, consumers may
alter consumption basket contents
– “chaining” CPI measures to allow for changing
baskets
• Introduction of new goods
– New goods offer more variety, to enhance value
of dollars spent and reduce “cost of standard of
living”
5
PROBLEMS IN COL
MEASUREMENT
• Unmeasured quality change
– Deterioration of quality reduces value of dollar
spent on good
– Adjustment to prices to allow for change of
quality
• Asset price inflation versus g&s (flow)
inflation
6
EXPECTATIONS OF
INFLATION
7
GDP DEFLATOR vs CPI
• GDP deflator measures domestic
production but CPI includes foreign g&s
• GDP basket is actual production but CPI
is fixed basket
8
AUSTRALIAN GDP
DEFLATOR vs CPI
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USES OF INFLATION
CORRECTION
• Dollar figures from different times
• Indexation
– Basic wage claims
– Pension benefits
– Public utility prices
– Bond values
• Real and nominal interest rates
• Real and nominal exchange rates
10
INTERNATIONAL PRICE
INDICES
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