Chapter 24 ECON 2

How does the typical consumer divide spending among various categories of goods and services?

41% Housing 17% Transportation 15% Food and Beverage 7% Education and communication 7% Medical care 6% Recreation 4% Apparel 3% Other goods and services

Producer Price Index is...?

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

Consumer Price Index (CPI) is...?

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

How to calculate dollar figures in different times...?

Amount in Bs dollars = Amount in year As dollars x (Price level B / Price level in year A)

If the price of imported French wine rises, is the consumer price index or the GDP deflator affected more? Why?

CPI because it reflects prices of all goods and services bought

Changes in the PPI are useful in predicting...?

Changes in the CPI

What problems are associated with substitution bias?

If a price index is computed assuming a fixed basket of goods, it ignores the possibility of consumer substitution and, therefore, overstates the increase in the cost of living from one year to the next.

What problems are associated with unmeasured quality change?

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 you are getting a lesser good for the same amount of money.

**? Over a long period of time, the price of a candy bar rose from $0.20 to $1.20. Over the same period, the consumer price index rose from 150 to 300. Adjusted for overall inflation, how much did the price of a candy bar change?

Inflation rate = 300-150/150 x 100 = 100% 100% of $0.2 = $.2 (Increase due to inflation) Real interest rate = $1.2 (nominal) - $0.4 (interest) = $0.8

Who computes and reports the CPI?

The Bureau of Labor Statistics (BLS)

What is indexation?

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

Because consumers can sometimes substitute cheaper goods for those that have risen in price, a.the CPI overstates inflation. b.the CPI understates inflation. c.the GDP deflator overstates inflation. d.the GDP deflator understates inflation.

a.

The consumer price index measures approximately the same economic phenomenon as a.Nominal GDP. b.Real GDP. c.The GDP deflator. d.The unemployment rate.

c.

If a Pennsylvania gun manufacturer raises the price of rifles it sells to the U.S. Army, its price hikes will increase a.both CPI and the GDP deflator. b.neither the CPI nor the GDP deflator. c.the CPI but not the GDP deflator. d.the GDP deflator but not the CPI

d.

If the consumer price index is 200 in year 1980 and 300 today, then $600 in 1980 has the same purchasing power as _______ today. a.$400 b.$500 c.$700 d.$900

d.

You deposit $2,000 in a savings account, and a year later you have $2,100. Meanwhile, the consumer price index rises from 200 to 204. In this case, the nominal interest rate is _____ percent, and the real interest rate is _______ percent. a.1, 5 b.3, 5 c.5, 1 d.5, 3

d.

What are the long-run determinants of price levels and related variables?

money supply, inflation, and nominal interest rate.

Inflation rate in 2 years =

(CPI in year 2 - CPI in year 1)/CPI in year 1 x 100

Consumer Price Index =

(Price of basket of goods and services in current year)/Price of basket in base year) x 100

The consumer price index overstated inflation by about ____% point per year.

1%

How is CPI calculated?

1. Fix the basket - fixed quantity 2. Find the price - at each desired point in time 3. Compute the basket's cost - Same basket quantities with different prices result in varying basket costs at different points in time 4. Choose a base year and compute index - Base year serves as a benchmark against which other years are compared.

What can you use to measure inflation rate?

1. GDP delfator 2. Consumer price index

What are 3 issues associated with CPI being a measure of the cost of living?

1. Substitution bias 2. Introduction of new goods 3. Unmeasured quality change.

Two important differences that cause GDP and CPI to diverge are...?

1. The GDP deflator reflects the prices of all goods and services produced domestically, whereas the CPI reflects the prices of all goods and services bought by consumers. Ex: When the price of oil rises, the CPI rises by much more than does the GDP deflator. 2. The CPI compares the price of a fixed basket of goods and services to the price of the basket in the base year. By contrast, the GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year. Thus, the group of goods and services used to compute eh GDP deflator changes automatically overtime.

Describe the three problems that make the consumer price index an imperfect measure of the cost of living.

1. substitution bias- if the price of a good increases, quantity demanded decreases and consumers will substitute this good for something else, so quantity demanded of the substitute increases. 2. introduction of new goods- new goods = more variety, causing value of the dollar to increase which isn't shown in CPI 3. unmeasured quality change- when quality of a good decreases and price remains the same, value of the dollar decreases

Which do you think has a greater effect on the consumer price index: a 10 percent increase in the price of chicken or a 10 percent increase in the price of caviar? Why?

A 10 percent increase in the price of chicken would have a greater effect on the consumer price index because it is purchased by the typical family, and would have to spend more money to maintain the same standard of living that includes chicken.

What problems are associated with the introduction of new goods?

Because the consumer price index is based on a fixed basket of goods and services, it does not reflect the increase in the value of the dollar that arises from the introduction of new goods.

What is the job of the method of statistics called "consumer price index?"

CPI is a method of turning dollar figures into meaningful measures of purchasing power. This is used to monitor changes in the cost of living over time.

To understand how much a person earns in a savings account, we need to consider...?

Interest rate and changes in prices

The interest rate that measures the change in dollar amount is...?

Nominal interest rate

Real interest rate =

Nominal interest rate - Inflation rate

Explain the meaning of nominal interest rate and real interest rate. How are they related?

Nominal- reported without a correction for effects of inflation Real- interest rate corrected for effects of inflation

What happens to purchasing power as inflation increases?

Purchasing power decreases

The interest rate corrected for inflation is called...?

Real interest rate

What are long run determinants of real GDP and related variables?

Saving, investment, real interest rates, and unemployment.

The BLS calculates ________ price indexes; specific for metropolitan areas and particular categories of goods and services.

Several

What is inflation rate?

The percentage change in the price index from the preceding period.

What is the goal of CPI?

To gauge how much incomes must rise in order to maintain a constant standard of living.

The largest component in the basket of goods and services used to compute the CPI is a.food and beverages. b.housing. c.medical care. d.apparel.

b.