Chapter 6 - Measuring the Cost of Living

Calculating CPI

-"Fix the basket" whats typically in the shopping basket -Find the prices of each good in the basket at each point in time -Compute Basket's cost -Choose a base year and compute the index 100 X (Cost of basket in current year/Cost of basket in base year) -compute the inflation rate [CPI this year-last year CPI]/last year CPI

Differences between GDP deflator and CPI:

-GDP deflector reflect the prices of all goods/services PRODUCED DOMESTICALLY, while CPI reflects prices of all goods/services BOUGHT BY CONSUMERS.

Real interest rate

-corrected for inflation -rate of growth in the purchasing power of a deposit or debt = (nominal rate)-(inflation rate)

You deposit $2,000 in a saving account, and a year later you have $2,020. Meanwhile, the CPI rises from 200 to 204. In this case, the nominal interest rate is _____ percent, and the real interest rate is _____ percent.

1, -1 -to find nominal (doesn't account for inflation) 2020/2000=1% -to find real interest rate = nominal-inflation = 1 - (204/200)

What in the CPI's Basket?

Housing (42%) Transportation (16%) Food and Beverages (15%) Medical Care (8%) Education and Communication Recreation Apparel

If the price of Italian shoes imported into the United States increases, then:

The CPI will increase (consumer bought them), but the GDP will not increase (consumption increases but net exports decreases)

Consumer Price Index (CPI)

a measure of the overall cost of goods and services bought by a typical consumer. -approximately the same as the GDP deflator -affected by importing goods unlike GDP deflator

Nominal interest rate

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

Problems with the CPI- Substitution Bias

over time, some prices rise faster than others. consumers substitute toward goods that become relatively cheaper, mitigating the effects of price thus, the CPI OVERSTATES increases in the cost of living

amount in today's dollars =

past amount in year T's dollars X [CPI today/ CPI in year T]

Indexation

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