Chapter 21Measuring The Cost Of Living

Front 1

The Consumer Price Index (CPI)

Back 1

A measure of the over alll prices of the goods and services bought by a typical consumer

Front 2

The inflation rate

Back 2

is the percentage change in the price level from the previous period.

Front 3

Inflation

Back 3

Is the term used to describe a situation in which the economy’s overall price level is rising.

Front 4

what is used to monitor changes in the cost of living over time.

Back 4

CPI

Front 5

Which office reports the CPI in the UK? Europe? And the USA?

Back 5

The Office of National Statistics for UK and Eurostat for Europe, and the (Departament of commers) report the CPI each month.

Front 6

What are the five stages of calcuating CPI?

Back 6

1. Fix the basket: Survey consumers to determine a fixed basket of goods.

2. Find the prices: Find the prices of each good in a year.

3. Compute the Basket's cost: Use the data on prices to calculate the cost of th basket of goods and services at different times.

4. Choose a base year and compute the Index: Compute the CPI in each year.

5. Compute the infation rate: Use the CPI to compute the inflation rate from previous year.

Front 7

How do we compute the CPI?

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We designate one year as the base year, to calculate the index, the price of the basket of goods and services in each year is devided by the price of the backet in the base year, and tthat ratio is then multiplied by 100, the resulting number is the CPI

Front 8

How do we calculate the inflation rate?

Back 8

Front 9

What are the key issues that cause the CPI to overstate the true cost of living?

Back 9

1. Substitution bias2. Introduction of new goods3. Unmeasured quality changes

Front 10

what do we mean by Substitution Bias when we refare to problims in CPI?

Back 10

* The basket does not change to reflect consumer reaction to changes in relative prices. a- Consumers substitute toward goods that have become relatively less expensive. b- The index overstates the increase in cost of living by not considering consumer substitution.

Front 11

what do we mean by introduction of new Goods when refearing to the problems in measuring the CPI.

Back 11

Introduction of New Goods refares to:* The basket does not reflect the change in purchasing power brought on by the introduction of new products. a- New products result in greater variety, which in turn makes each euro more valuable. b- Consumers need less money to maintain any given standard of living.

Front 12

what do we mean by Unmeasured Quality Changes

when refearing to the problems in measuring the CPI.

Back 12

* If the quality of a good rises from one year to the next, the value of a euro rises, even if the price of the good stays the same.* If the quality of a good falls from one year to the next, the value of a euro falls, even if the price of the good stays the same.* The ONS tries to adjust the price for constant quality, but such differences are hard to measure.

Front 13

whr are the issue over accurate measurement is important?

Back 13

because many government programs use the CPI to adjust for changes in the overall level of prices.

Front 14

The producer price index

Back 14

a measuremment of the cost of a basket of goods and services bought by firms rather than consumers.

Front 15

FYI: what is Hedinic quakity adjustment?

Back 15

This involves working out the avarage characteristics of the average (Item, Good, product) and then adjusting the price when one of these average characteristics increase. used in order to limit the issues with CPI problems in turms of adjusting for quality when price stays the same but the quality of a product improves.

Front 16

how do we calculate the GDP deflator?

Back 16

Front 17

What are the two main differences between GDP deflator and CPI?

Back 17

1- GDP deflator reflects the prices of ALL goods and services produced domestically, whereas CPI reflects the prices of all goods and services bought by consumers. EX( things bought by the airforce, it is mainly important when the price of oil changes, when oil rises the CPI rises more than the GDP deflator because the majority of oil is imported from the middle east.

2- CPI compares the prices in a fixed basket of goods that consumers buy, buy GDP deflator compares the prices of all goods and services.

Front 18

Explain briefly what the consumer prices index is trying to measure and how it is constructed?

Back 18

The consumer price index tries to measure the overall cost of the goods and services bought by a typical consumer. It is constructed by surveying consumers to fix a basket of goods and services that the typical consumer buys, finding the prices of the goods and services over time, computing the cost of the basket at different times, and then choosing a base year. To compute the price index, we divide the cost of the market basket in the current year by the cost of the market basket in the base year and multiply by 100.

Front 19

Henry Ford paid his workers $5 a day in 1914. If the U.S. consumer price index was 10 in 1914 and 195 in 2005, how much is the Ford daily paycheque worth in 2005 dollars?

Back 19

Since Henry Ford paid his workers $5 a day in 1914 and the consumer price index was 10 in 1914 and 195 in 2005, then the Ford daily paycheque was worth $5 195/10 = $97.50 a day in 2005 dollars.

Front 20

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?

Back 20

A 10 percent increase in the price of chicken has a greater effect on the consumer price index than a 10 percent increase in the price of caviar because chicken is a bigger part of the average consumer's market basket.

Front 21

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

Back 21

The three problems in the consumer price index as a measure of the cost of living are: (1) substitution bias, which arises because people substitute toward goods that have become relatively less expensive; (2) the introduction of new goods, which are not reflected quickly in the CPI; and (3) unmeasured quality change.

Front 22

If the price of a military aircraft rises, is the consumer price index or the GDP deflator affected more? Why?

Back 22

If the price of a military aircraft rises there is no effect on the consumer price index, since military aircraft are not consumer goods. But the GDP deflator is affected, since military aircraft are included in GDP as a part of government purchases.

Front 23

Over a long period of time, the price of a candy bar rose from $0.10 to $0.60. Over the same period, the consumer price index rose from 150 to 300. Adjusted for overall inflation, how much did the price of the candy bar change?

Back 23

Since the overall price level doubled, but the price of the candy bar rose sixfold, the real price (the price adjusted for inflation) of the candy bar tripled.

Front 24

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

Back 24

The nominal interest rate is the rate of interest paid on a loan in dollar terms. The real interest rate is the rate of interest corrected for inflation. The real interest rate is the nominal interest rate minus the rate of inflation.

Front 25

When deciding how much of their income to save for retirement, should workers consider the real or the nominal interest rate that their savings will earn? Explain.

Back 25

In deciding how much income to save for retirement, workers should consider the real interest rate, since they care about their purchasing power in the future, not the number of dollars they will have.

Front 26

Whensome money amount is automatically corrected for inflation by law or contract,the amount is said to be--------------- forinflation.

Back 26

indexed

Front 27

How do we adjust salaries for inflation?

Back 27

Front 28

Indexed

Back 28

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

Front 29

COLA or Cost-of-living-allowance

Back 29

a provision in long contracts between firms and unions that automatically raises the wage each year based on the CPI or other measueus.

Front 30

The nominal interest rate

Back 30

Is the interest rate usually reported and not corrected for inflation. •It is the interest rate that a bank pays.

Front 31

The real interest rate

Back 31

is the nominal interest rate that is corrected for the effects of inflation.

Front 32

Realinterest rate

Back 32

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Front 35

Why is it important to adjust or inflation when considering wage increases and the returns from any financial investment?

Back 35

try to answer it