Chapter 11 - Measuring the Cost of Living
Chapter 11 - Measuring the Cost of Living Econ 110
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This 2 page Class Notes was uploaded by Erin Payne on Monday May 9, 2016. The Class Notes belongs to Econ 110 at Kansas State University taught by Dr. Al-Hamdi in Spring 2016. Since its upload, it has received 16 views. For similar materials see principles of Macroeconomics in Economcs at Kansas State University.
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Date Created: 05/09/16
Week 8 March 7th March 9th Spring 2016 Chapter 11 Notes Measuring the Cost of Living ● Consumer Price Index (CPI) ○ Measure of the overall level of prices. ○ Measure of the overall cost of goods and services. ■ Bought by a typical consumer. ○ Bureau of Labor Statistics. ● Cost of living = ∑ Cost of each item = ∑ (Price x Quantity) ○ Where quantity is fixed (because most families do not change what they buy). ● Calculating CPI ○ Fix the basket. ■ Which prices are most important to the typical consumer. ■ Different weight. ○ Find the prices. ■ At each point in time. ○ Compute the basket’s cost. ■ Same basket of goods. ■ Isolate the effects of price changes. ○ Choose a base year and compute the CPI. ■ Base year = benchmark. ● Price of basket of goods and services in current year. ● Divided by price of basket in base year. ● Times 100. ■ Compute the inflation rate. ■ Inflation rate in year 2 = PI inCPI in year 1 in X 100 ● Inflation rate ○ Percentage change in the price index. ■ From the preceding period. ● Producer price index, PPI. ○ Measure of the cost of a basket of goods and services bought by firms. ○ Changes in PPI are often thought to be useful in preceding changes in CPI. ● Problems in measuring the cost of living ○ Substitution bias. ■ Prices do not change proportionately. ■ Consumers substitute toward goods that have become relatively less expensive. ○ Introduction of new goods. Notes Key:Bolded texts = most important facts stressed by professor. ∴ symbol = “Therefore” or “In other words”. “ ” = Specific definition or word choice provided by instructor. Week 8 March 7th March 9th Spring 2016 ■ More variety of goods. ○ Unmeasured quality change. ■ Changes in quality. ● GDP deflator ○ Ratio of nominal GDP to real GDP. ○ Reflects prices of all goods and services produced domestically. ○ Compares the price of currently produced goods and services. ■ To the price of the same goods and services in the base year. ● CPI ○ Reflects prices of goods and services bought by consumers. ○ Compares price of a fixed basket of goods and services. ■ To the price of the basket in the base year. ● For imports, GDP will not change, however CPI will. ● CPI more drastically shows inflation rate. ● For exports, GDP will be affected, while CPI will not. Price level in period T ● Amount in period T = Amount in previous period X Price level in previous period ● Dollar figures from different times ○ Amount in today s dollars = Amount in year T dollars X Price level in year T ● Indexation ○ Automatic correction by law or contract. ○ Of a dollar amount. ○ For the effects of inflation. ○ COLA: Cost of living allowance. ● Nominal interest rate ○ Interest rate as usually reported. ○ Without a correction for the effects of inflation. ○ “Interest rate as state without taking inflation into account.” ● Real interest rate ○ Interest rate corrected for the effects of inflation. ○ = Nominal interest rate Inflation rate. ○ “Interest rate after accounting for inflation.” Notes Key: Bolded texts = most important facts stressed by professor. ∴ symbol = “Therefore” or “In other words”. “ ” = Specific definition or word choice provided by i structor.
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