Cost of Living Essay examples

1980 Words May 17th, 2012 8 Pages
Measuring the Cost of Living

Overview:

Last time we discussed the most important measure of economic well-being – real, per capita GDP. Further, if we want to see how our economic well-being is changing over time, we can calculate how real GDP is changing in percentage terms (for example, real GDP grew 4% last quarter).

Now, we turn our attention to another important measure of the economy.

We want to measure how the cost of living changes over time.

The main intuition here is that, over time, peoples’ incomes and the prices of goods and services increase. 30 years ago an ice cream sundae cost $1 and a typical economics professor earned $35,000. Now, a (bad) ice cream sundae costs $4.50 and a typical economics professor
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From 2000 to 2001: Nominal GDP doubled but real GDP only went up 50% - so we must have had some large price increases that bumped up nominal GDP.

From 2001 to 2002: Both nominal and real GDP increased by the same amount ($50), which must mean that the only thing causing these increases was an increase in the quantities – we had no inflation!

So, you can see that we can use the relationship between nominal and real GDP to understand changes in the cost of living.

The question now is how, precisely, we do this:

The GDP Deflator = (Nominal GDP/Real GDP)*100.

GDP Deflator is the ratio of nominal GDP to real GDP…

So, For example: if nominal GDP = 200 and real GDP = 100 then the GDP deflator = 200.

Now, let’s move on to our other measure of the cost of living: the consumer price index:

The Consumer Price Index:

Background:

Suppose upon graduation you have to decide between two job offers: one in Richmond that will pay you $35,000 a year, and one in Indianapolis that will pay you $40,000 a year. Which offer affords you a better living standard?

To answer this question you need to compare the cost of living in Richmond to Indianapolis and then adjust the income figures accordingly.

My question to you is: How can you do this?

The Consumer Price Index is the way to go: it is a measure of the overall cost of the goods and services bought by a typical consumer.

As such, we…

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