Chapter 7

Bias in CPI

-CPI is an index of overall price level; some price in basket rise and some fall -Market basket changes over time; new products, retired products. Technological innovations improve quality of goods. -It is not always easy to determine how much of a new product represents an increase in quantity and quality and how much represents a higher price. So the arrival of new goods puts upward bias into CPI and its measure of inflation rate. CPI counts too much of any price rise as inflation and overstates inflation. -Substitution bias- consumers substitute cheaper goods for more expensive goods

Cost of living index

-Measure of change in amount of money people need to spend to achieve a given standard of living. -Sometimes called CPI

Nominal wage rate real wage rate

-average hourly wage rate measured in current dollars -average hourly wage rate measured in dollars of a given reference base year

4 steps to calculating CPI

1. Survey consumers 2. Survey retailers 3. Determine cost of market basket 4. Compare cost of market basket across time periods Base year serves as basis for comparison with prices in another year. It is always 100.

If the cost of a market basket is $150 in 2005 and $200 in 2015, the price index for 2005 using 2015 as the base year is...

75

Price index

A number whose movement reflects movement in average price level.

Disinflation

A reduction in the inflation rate.

Hyperinflation

An extremely high rate of inflation above 50% a month

Why can deflation be bad

As prices fall, consumers put off on purchases, wages go up for employees, firms lay off workers

GDP Deflator (GDP Price index) Formula

Average of current prices of all goods and services included in GDP. Expressed as a % of base year prices. GDP Deflator= (nominal GDP/ real GDP) * 100

Market Basket

Combination of goods and services that the typical consumer purchases during period.

How is GDP deflator different from CPI

GDP deflator includes prices of all goods and services produced in US. Not just a market basket.

Inflation

General rise in price level.

Consumer price index

Measure of average of prices paid by urban consumers for a fixed market basket of consumption goods and services.

Consumer Price Index

Measure of average of prices paid by urban consumers for fixed market basket of consumption goods and services. Measures how much more or less it costs to buy a market basket from one period to the next. Calculated as current cost of a fixed basket of consumer goods divided by cost of basket in base period

Inflation rate define and formula

Measured as percent change in prices from one period to another.

Inflation rate

Percentage change in price level from one year to the next

Deflation

Price level is falling and inflation rate is negative.

What does a CPI of 156 mean?

Prices increased by 56% (100 to 156) between 2008 and 2013. inflation rate was 56% from 2008 to 2013.

Real wage rate formula

Real wage rate in (year)= nominal wage rate in that year/CPI in that year. Multiply by 100

Converting dollar values of years

RealEarnyearA$ = NomEarnyearB$ (CPIA/CPIB) Notice year a has CPI in numerator

Who is affected by inflation

Social security recipients, pensioners, others receiving fixed incomes. Cost of living adjustment- Adjustment to incomes/ benefits as the price level/ cpi rises

Nominal value

Value expressed in dollars of current period.

Real value

Value expressed in units of constant purchasing power or reference base year.