Macro Econ Chapter 24

BLS

Bureau of Labor Statistics

Another example of calculating CPI and the inflation rate

Calculating the Consumer Price Index and the Inflation Rate: Another Example Base Year is 2002. Basket of goods in 2002 costs $1,200. The same basket in 2004 costs $1,236. CPI = ($1,236/$1,200) 100 = 103. Prices increased 3 percent between 2002 and 2004.

How often does the Bureau of Labor Statistics (BLS) computes and reports the Consumer Price Index (CPI)

Every month

True or False The real interest rate equals the nominal interest rate plus the rate of inflation.

False Real Interest rate = nominal interest rate - rate of inflation

True or False? The inflation rate is used to measure the overall level of prices in the economy.

False, The index is used

True or False The CPI is a perfect measure of the cost of living for the following three reasons: substitution bias, the introduction of new goods, and unmeasured changes in quality.

False, Imperfect

True or False Dollar figures from different points in time do represent a valid comparison of purchasing power.

False, they don't

What two tools do economists and policymakers monitor to gauge on how quickly prices are rising.

GDP deflator and the CPI

Unmeasured Quality Changes

If the quality of a good rises from one year to the next, the value of a dollar 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 a dollar falls, even if the price of the good stays the same. The BLS tries to adjust the price for constant quality, but such differences are hard to measure.

Inflation example

Inflation in 2007 (207-202)/202 = 2.5%

This term represents a payment in the future for a transfer of money in the past.

Interest

What's the purpose of measuring the overall level of prices in the economy?

It allows us to compare dollar figures from different times Compare a dollar figure from the past to the present.

Is the CPI a perfect measure of the cost of living?

No

GDP deflator

Nominal GDP/Real GDP x 100

What's used adjust the different effects of inflation correctly when comparing dollar amounts from different times?

Price indexes

The BLS also calculates

Producer Price Index

You borrowed $1,000 for one year. Nominal interest rate was 15%. During the year inflation was 10%. What's the Real Interest Rate?

Real interest rate = Nominal interest rate - Inflation = 15% - 10% = 5%

Real interest rate formula

Real interest rate = nominal interest rate - inflation r = i - pie symbol

What's the difference between GDP Deflator and CPI when it comes to goods and services?

The GDP deflator reflects the prices of all goods and services produced domestically the CPI reflects the prices of all goods and service bought by consumers

Indexing

The automatic correction by law or contract of a dollar amount for the effects of inflation.

Substitution Bias

The basket doesn't change to 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

The basket doesn't reflect the change in purchasing power brought on by the introduction of new products. (new products result in greater variety, which in turn, makes each dollar more valuable.) (Consumers need fewer dollars to maintain any given standard of living.)

True or False Because of measurement problems, the CPI overstates annual inflation by about 1 percentage point.

True

True or False In addition, the CPI uses a fixed basket of goods, while the GDP deflator automatically changes the group of goods and services over time as the composition of GDP changes.

True

True or False The GDP deflator differs from the CPI because it includes goods and services produced rather than goods and services consumed.

True

True or False? The consumer price index shows the cost of a basket of goods and services relative to the cost of the same basket in the base year.

True

True or False? The percentage change in the CPI measures the inflation rate.

True

Your basket has 4 hot dogs and 2 hamburgers. The price of Hot Dogs and Hamburgers are the following. HD Ham 2010 $1 $2 2011 $2 $3 2012 $3 $4 Compute CPI and use CPI to compute the inflation rate

Upload image on pg. 515

Inflation Rate formula

Use this formula for Year 2 and above. Don't use for base year.

Producer Price Index

a measure of the cost of a basket of goods and services bought by firms.

Consumer Price Index (CPI)

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

Hyperinflation

an extremely high rate of inflation

Inflation

economy's overall price level is rising

When some dollar amount is automatically corrected for inflation by law or contract, the amount is said to be _____ for inflation.

indexed

nominal interest rate

interest rate usually reported and not corrected for inflation It's the annual percentage increase in the dollar value of an asset

When the CPI rises, a typical family has to spend ______ dollars to maintain the same standard of living.

more

real interest rate

nominal interest rate that's corrected for the effects of inflation

The substitution bias, introduction of new goods, and unmeasured quality changes cause the CPI to _____ the true cost of living.

overstate

producer price index

the cost of a basket of goods and services bought by firms rather than consumers

The goal of the consumer price index is to measure changes in _________

the cost of living

Inflation rate

the percentage change in the price level from the previous period.

What is CPI used for?

to monitor changes in the cost of living over time

True or False Various laws and private contracts use price indexes to correct for the effects of inflation.

true

Do many government programs use the CPI to adjust for changes in the overall level of prices.

yes

Inflation rate formula

π2010 = ((P2010 - P2009 ) / P2009 )*100

deflation

π2010 = ((P2010 - P2009 ) / P2009 )*100 < 0

Example of Hyperinflation (Germany).

-In 1923, German employers paid workers twice a day -Magnifies the costs of inflation -Minimize your cash holding A study of market economies, 1960 - 1996 showed 45 episodes of high inflation (100+%) in 25 countries Real GDP/person fell by an average of 1.6% per year Real consumption/ person fell by an average of 1.3% per year Real investment per person fell by an average of 3.3% per year

5 steps to compute CPI

1. Fix the Basket (Determine which prices are most important to the typical consumer) 2. Find the prices (find the prices of each o the goods and services in the basket at each point in time) 3. Compute the basket's cost (add the prices of everything) 4. Choose a base year and compute the index 5. Compute the inflation rate. (next slide)

What are the problems with CPI

1. Substitution bias (Some prices rise more than others). A price index ignores the possibility of customer substitution (ice cream and frozen yogurt), which overstates the increase in the cost of living. Therefore, the cost of living is much larger than the customers actually experience. 2. Introduction of new goods. (If you're offered a $100 gift card to gamestop [for games only] or a $100 gift card to walmart, you'd choose walmart). CPI is based on a basket of goods and services, it doesn't reflect the increase in the value of the dollar that arises from the introduction of new goods. Unmeasured quality changes, If the quality of a good deteriorates from one year to the next while its price remains the same, the value of a dollar falls. Because of this, you are getting a lessor good for the same amount of money. (hardware failures on computers)

1. The consumer price index compares the price of a ________ of goods and services to the _______ in the base year 2. GDP deflator compares the price of _____________ to the price of the same goods and services in the base year

1. fixed basket, price of the basket 2. currently produced goods