macro ch 11

CPI overstates inflation

Because consumers can sometimes substitute cheaper goods for those that have risen in price, ______

Suppose the typical consumer buys more bananas than oranges. In fixing the basket of goods and services for the purpose of calculating the consumer price index, the Bureau of Labor Statistics

places more weight on the price of bananas than on the price of oranges; the weights of the two prices are determined by surveying consumers.

what does it mean if the real interest rate is 5 percent

that the purchasing power of a deposit has grown 5 percent

find the prices

the bls collects data on the price of all the goods in the basket

real interest rate is used to

correct inflation

real interest rate

corrected for inflation rate of growth in purchasing power of a deposit or debt

chose a base year and compute the cpi

cost of basket of goods and services in the current year divided by the cost in the base year times 100 current year/ base year x 100

cola

cost of living adjustment

cpi is used to make

cost of living adjustments and to correct economic variables for effects of inflation

When the value of the dollar declines

cost of living increases

who uses a fixed basket

cpi gdp deflator uses a basket of currently produced goods and services this matters if diff prices are changing by different amounts

if price of domestically produced power tools increases then

cpi and deflator will both increase

increase of price of Toyota made in Japan effects

cpi bc its bought by consumers in us but doesn't effect gdp deflator

imported consumer goods is included in

cpi but not gdp deflator

whats included in the cpi basket

food housing apparel transportation medical care recreation education and communication

2 differences of cpi and gdp deflator

gdp deflator measures the prices of all goods but cpi measures only goods and services bought by consumers gdp deflator includes only goods produced domestically bc imported goods don't add to gdp

3 largest categories of consumer spending in basket of goods for consumer price index

housing, transportation, food and beverages

unmeasured quality change least severe

if quality goes down and becomes more expensive bc then a lot of ppl will not buy

how do u correct variables for inflation

use cpi

computes the baskets cost

use the prices to compute the total cost of the basket

is consumer price index a useful measure for cost of living

useful but not perfect

what happens when new goods are introduced

variety is increased so consumers find products that more closely meet their needs so dollars become more valuable

substitution effect

when one good remains constant and another rises when two goods rise the same amount

do cpi and gdp move together

yes

does cpi miss the increase of value of dollar

yes

does cpi miss substitution bias

yes bc it uses a fixed basket of goods

does BLS try to account for quality changes

yes but it probably misses some bc quality is hard to measure

does cpi change w quality changes

yes if bLS precisely adjusts it

nominal interest rate

interest rate not corrected for inflation rate of growth in the dollar value of a deposit or debt

changes in the quality of a good can

lead to either an increase or a decrease in the value of a dollar depending on if quality goes up and down

consumer price index

measure of overall prices measure of overall cost of goods and services bought by a typical consumer

cpi is calculated

monthly

substitution bias

over time, some prices rise faster than others consumers substitute toward goods that become cheaper, making price changes less severe

by not taking into account the possibility of consumer substitution, the CPI....

overstates the cost of living

compute the inflation rate

percentage change in cpi from preceding period cpi this year- cpi last year/ cpi last year

cpi overstates inflation by

.5 percent

consumer price index is computed and reported by

Bureau of labor statistics

Fix the basket

The Bureau of Labor Statistics (BLS) surveys consumers to determine what's in the typical consumer's "shopping basket."

indexation

a dollar amount is indexed for inflation if it is automatically corrected for inflation by law or in a contract

When the relative price of a good increases, consumers respond by buying

a smaller quantity of that good and a larger quantity of substitutes for that good.

inflation makes it hard to

compare dollar amounts from different times

inflation rate is calculated by

determining the percentage increase in the price index from the preceding period

the 2 measures of inflation

gdp deflator and cpi

increase of price of goods bought by firms or gov will show up in

gdp deflator but not cpi

a decrease in the price of domestically produced industrial robots will be reflected in

gdp deflator but not the cpi bc cpi is what consumers typically buy

capital goods are included in

gdp deflator if produced domestically but not cpi

if quality of a good goes down and price stays same then value of a dollar

goes down and cost of living increases

cpi basket is mostly

housing

unmeasured quality change most severe

if quality improves and price goes down

unmeasured quality change

improvements in quality of goods increases the value of each dollar

cpi overstates

increases in cost of living

is cpi a good measure of the cost of living

no because of substitution bias introduction of new goods unmeasured changes in quality

how to calculate real interest rate

nominal interest rate - inflation rate

economys inflation rate is the

percentage change in the price level from the previous period

if quality goes down and price stays same...

price stays same technically so you are paying more so CPI goes up

cpi is tied to

social security payments

An increase in the price of Irish whiskey imported into the United States will be reflected in

the U.S. CPI, but not the U.S. GDP deflator..

consumer price index is a measure of

the cost of living

what does it mean if nominal interest rate is 5 percent

the growth of the dollar value raised by 5 percent

increase in CPI automatically determines

- The COLA in many multi-year labor contracts. - Adjustments in Social Security payments and federal income tax brackets.

5 steps of calculating cpi

1. fix the basket 2. find the prices 3. compute the baskets cost 4. chose a base year and compute the cpi 5. compute the inflation rate