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Purdue AGEC 21700 - Consumer Price Index
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Lecture 20Outline of Last Lecture I. InflationA. Definition of InflationB. Examples of InflationII. Consumer Price IndexIII. How to Calculate InflationIV. Example Problem Outline of Current Lecture I. Basket of GoodsII. Calculate CPIA. Consumer Expenditure SurveyB. Weight the BasketIII. Transitory ShocksIV. CPI CriticismV. Producer Price IndexCurrent LectureThis lecture continues looking at the consumer price index, CPI. The basket of goods in the CPI is representative. This basket of goods is flexible. This basket of goods is also comparable. There are two issues with the CPI. One issue is substitution bias. This situation says that as prices increase, consumers will substitutegoods to find a relatively cheaper product. This causes changes to the “average” basket. The other issue is caused by new goods. When new inventions or modifications happen to goods, the basket will be changed. Next we will look at how the CPI is calculated in the United States. The first step is to do a consumer expenditure survey. This survey is a large and nationally representative survey of consumers and what they buy. Next, economists will look at the data obtained from the survey and generate a list of products. This list contains around 80,000 products in the United States and allows for different brands, sizes, ect… Then the goods start to be grouped into baskets of similar products. Next thousands of retailers are called in order to find out the prices of all the goods. Finally, the baskets are weighed based upon their importance to a family’s budget. For example, housing is weighted to 41%, food to 15%, ect…The prices of the goods are subject to what is called transitory shocks. These shocks make prices bounce around a certain point and bounce around the same level. For example, food prices depend on the weather. Core inflation is the path in the CPI inflation after taking out volatile prices. There is one main criticism against the CPI. It is accepted as being okay on average, but it may not be representative for any particular group. For example, elderly people may not spend as much money, as weighted out, on technology. They may also spend more money than “allotted” on healthcare. One possible suggested solution was to make an index for each group that is of interest. AGEC 217 1nd EditionJust like there is a consumer price index, there is also a producer price index (PPI). This is a price index for a basket of goods that producers consume. It is interesting to note that prices rise during periods of warfare, because resources are scarce. Prices tend to fall during periods of recessions or a depression. In the 1970s in the United States, there was a period of high inflation. This was due to bad monetary


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Purdue AGEC 21700 - Consumer Price Index

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