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20 Cards in this Set
- Front
- Back
CPI (calculation of index) =
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(Price of basket of goods and services in current year / Price of basket in base year) x 100
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CPI: 5 steps to calculate inflation rate
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1. survey consumers to determine a fixed basket of goods.
2. find the price of each good in each year. 3. compute the cost of the basket of goods in each year. 4. Choose one year as a base year and compute the CPI in each year. 5. Use the CPI to compute the inflation rate from the previous year |
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Inflation rate: calculation from CPI
Inflation rate in year 2 = |
[(CPI in year 1 - CPI in year 1) / CPI in year 1] x 100
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Substitution bias
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The price index is computed assuming a fixed basket of goods, and therefore ignores the possibility of consumer substitution, and therefore overstates the increase in the cost of living from one year to the next.
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Producer Price Index
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a measure of the cost of a basket of goods and services bought by firms
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Introduction of new goods as a problem for CPI
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As new goods are introduced, consumers have more choices and so each dollar is worth more. This is not reflected in CPI, which assumes a fixed basket.
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Indexation
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the automatic correction by law or contract of a dollar amount for the effects of inflation
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Real interest rate
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the interest rate corrected for the effects of inflation
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Nominal interest rate
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the interest rate as usually reported without correction for the effects of inflation
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Differences between GDP Deflator and CPI
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1. GDP deflator reflects the price of all goods and services produced domestically; CPI reflects the price of all goods and services bought by consumers.
2. CPI compares prices of a fixed basket; GDP deflator compares prices of currently produced goods and services. |
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Dollar figures from different times (calculation)
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Amount in today's dollars = amount in year t x (price level today / price level in year t)
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Real interest rate (calculation) =
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nominal interest rate - inflation rate
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T or F: nominal interest rates in the US have almost always exceed real interest rates.
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True. The U.S. has experienced rising consumer prices in almost every year since 1965. Contrast: Japan in recent years has experienced deflation, and nominal interest rates will be lower than real interest rates.
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Consumer Price Index (CPI)
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a measure of the overall cost of the goods and services bought by a typical consumer
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Inflation
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a situation in which the economy's overall price level is rising
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Inflation Rate
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the percentage change in the in the price level from the previous period
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Fixing the basket (CPI calculation)
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Baskets are weighted towards the prices that are most important to the consumer (what they buy the most of). BLS sets the weights through consumer surveys.
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Finding the prices (CPI calculation)
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Find the prices of each of the goods and services in the basket at each point in time
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Computing the basket's cost (CPI calculation)
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Use the data on prices to calculate the cost of the fixed basket of goods and services at different times
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Choose a base year and compute the Index (CPI calculation)
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Designate one year as the base year (becomes the denominator)
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