Transcript Ch. 23 Outline

CPI
Define It:
Overall cost of
Goods and
services
Bought by
typical
consumer
Compare
components of
CPI to GDP
Calculate CPI
1. Fix the basket
– Set by BLS (In the News p.516)
2. Find the prices
3. Compute Basket Cost (Price of Basket)
– Q is now held constant to base year (think about
what we are trying to measure and what we want to
isolate
– Compare to RGDP
4. Compute the Index
current yr basket price
x 100 = CPI
base yr basket price
Index #: no $, no %
5. Inflation Rate :
% change in CPI
Producer Price Index
• Measures the cost of a basket of goods and
services bought by firms rather than
consumers
Problems in Measuring Cost of Living
1. Substitution Bias – When prices change,
consumers will respond by buying goods
whose prices have fallen, not original goods
2. Introduction of New Goods – Gives more
variety to choose from, allowing consumers
to reduce costs
3. Unmeasured quality change – BLS tries to
adjust for changes in a good’s quality, either
up or down
Problems in Measuring Cost of Living
• All the issues tend to create overstated
inflation rates based on CPI
• This becomes an issue because COLA tied to
Social Security
GDP Deflator vs. CPI
• Both used to measure change in prices
• Deflator measures prices of all goods/services
produced domestically while CPI focuses on
goods/services bought by consumers
• CPI based on fixed basket, Deflator based on
currently produced goods
• They usually move in same direction
Dollar Figures from Different Times
• For turning dollar figures from past years into
today’s dollars
Amount in today’s dollars =
Price Level Today
Amt in year T dollars X ________________
Price Level in year T
Indexation
• When a dollar amount is automatically
corrected for changes in price level by law or
contract, the amount has been indexed for
inflation
Real and Nominal Interest Rates
• Real Interest Rate =
Nominal interest Rate – Inflation Rate
• Nominal interest rate tells you how fast the
number of dollars in your bank account rises
over time; real interest rate tells you how fast
the purchasing power of your bank account
rises over time