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ISU ECON 102 - Measuring cost of living

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Chap 11, Mankiw - Measuring cost of livingSlide 2Calculating the Consumer Price Index and the Inflation Rate: An ExampleSlide 4Slide 5Slide 6Slide 7What’s in the CPI’s Basket?Slide 9Slide 10Slide 11Slide 12Slide 13Slide 141Chap 11, Mankiw - Measuring cost of living•The price indices – consumer, producer•Issues related to the measurement of cost of living•Adjusting variables for the rate of inflation2I. The price indicesthe consumer price index (CPI) the producer price index (PPI) steps in calculating CPI and measuring cost 1. 2. 3. 4. 5.3Calculating the Consumer Price Index and the Inflation Rate: An ExampleStep 1:Survey Consumers to Determine a Fixed Basket of Goods4 hot dogs, 2 hamburgers4Calculating the Consumer Price Index and the Inflation Rate: An ExampleYearPrice ofHot dogsPrice of Hamburgers2001 $1 $22002 $2 $32003 $3 $4Step 2: Find the Price of Each Good in Each Year5Calculating the Consumer Price Index and the Inflation Rate: An ExampleStep 3: Compute the Cost of the Basket of Goods in Each Year6Calculating the Consumer Price Index and the Inflation Rate: An ExampleStep 4: Choose One Year as the Base Year (2001) and Compute the Consumer Price Index in Each Year7Calculating the Consumer Price Index and the Inflation Rate: An ExampleStep 5: Use the Consumer Price Index to Compute the Inflation Rate from Previous Year8HousingFood/BeveragesTransportationMedical CareApparelRecreationOtherEducation andcommunicationWhat’s in the CPI’s Basket?40%40%16%16%17%17%6%6%5%5%6%6%5%5%5%5%9II. Issues in the measurement of cost of livingA. Problems in constructing the CPI1. Substitution biasConsumers substitute toward goods and away The basket The index _____________ the increase in cost of living by not considering consumer substitution.ex:102. Introduction of new goods The basket New products result in , which in turn makes each dollar ex:3. Unmeasured quality changeIf the quality of a good rises from one year to the next, the value of a dollar , even if the price of the good .By not ex:11B. The GDP Deflator versus the Consumer Price IndexBoth the GDP deflator and the consumer price index measures how quickly prices are rising - two important differences between the two,1. The GDP deflator reflects the prices of all goods and services and includes The CPI reflects the prices of all goods and services 2. The CPI compares the price of a fixed basket of goods & services The GDP deflator compares the price of currently121965Percentper Year1510501970 1975 1980 1985 1990 19952000CPITwo Measures of InflationGDP deflator13III. Correcting for effects of inflationdeflating dollar figures from different timessalary in 2006 dollars = salary in 2000 dollars x Suppose US economy has a 3% inflation rate. If the CPI for 2000 is 100, (price level in 2006/price level in 2000) = A person getting $50,000 in 2000 must get today, in order to enjoy the same standard of livingindexation of contractsThe above formula is very often used to write salary or other financial contractsreal and nominal interest ratesReal interest rate = nominal interest rate – inflation rate141965Interest Rates(percent per year)151050-51970 1975 1980 1985 1990 19951998Nominal interest rateReal interest rateReal and Nominal Interest


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