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23 MEASURINGTHECOSTOF LIVING WHAT’SNEW:
TheIntheNewsboxon“Mr.IndexGoestoHollywood”hasbeenupdatedandisnowaCaseStudywithaWebsitereferencewherestudentscanobtaincontinuallyupdatedinformation.ThereisalsoanewIntheNewsboxon“ACPIforSeniorCitizens.”
LEARNINGOBJECTIVES:
Bytheendofthischapter,studentsshouldunderstand:
howtheconsumerpriceindex(CPIisconstructed.
whytheCPIisanimperfectmeasureofthecostofliving.
howtocomparetheCPIandtheGDPdeflatorasmeasuresoftheoverallpricelevel.
howtouseapriceindextocomparedollarfiguresfromdifferenttimes.
thedistinctionbetweenrealandnominalinterestrates.
KEYPOINTS:
1.
Theconsumerpriceindexshowsthecostofabasketofgoodsandservicesrelativetothe costofthesamebasketinthebaseyear.Theindexisusedtomeasuretheoveralllevelofpricesintheeconomy.Thepercentagechangeinthepricelevelmeasurestheinflationrate.
2.
Theconsumerpriceindexisanimperfectmeasureofthecostoflivingforthreereasons. First,itdoesnottakeintoaccountconsumers’abilitytosubstitutetowardgoodsthatbecome relativelycheaperovertime.Second,itdoesnottakeintoaccountincreasesinthe purchasingpowerofadollarduetotheintroductionofnewgoods.Third,itisdistortedbyunmeasuredchangesinthequalityofgoodsandservices.Becauseofthesemeasurementproblems,theCPIoverstatesannualinflationbyabout1percentagepoint.
3.
AlthoughtheGDPdeflatoralsomeasurestheoveralllevelofpricesintheeconomy,itdiffers fromtheconsumerpriceindexbecauseitincludesgoodsandservicesproducedratherthangoodsandservicesconsumed.Asaresult,importedgoodsaffecttheconsumerpriceindex butnottheGDPdeflator.Inaddition,whiletheconsumerpriceindexusesafixedbasketof Harcourt,Inc.itemsandderiveditemscopyright2001byHarcourt,Inc.
2Chapter23—MEASURINGTHECOSTOFLIVING
goods,theGDPdeflatorautomaticallychangesthegroupofgoodsandservicesovertimeas thecompositionofGDPchanges.
4.
Dollarfiguresfromdifferentpointsintimedonotrepresentavalidcomparisonofpurchasing power.Tocompareadollarfigurefromthepasttoadollarfiguretoday,theolderfigureshouldbeinflatedusingapriceindex.
5.
Variouslawsandprivatecontractsusepriceindexestocorrectfortheeffectsofinflation. Thetaxlaws,however,areonlypartiallyindexedforinflation.
6.
Acorrectionforinflationisespeciallyimportantwhenlookingatdataoninterestrates.The nominalinterestrateistheinterestrateusuallyreported;itistherateatwhichthenumberofdollarsinasavingsaccountincreasesovertime.Bycontrast,therealinterestratetakesintoaccountchangesinthevalueofthedollarovertime.Therealinterestrateequalsthenominalinterestrateminustherateofinflation.
CHAPTEROUTLINE:
I.
B.
a.
2.
b.
b. A. TheConsumerPriceIndex DefinitionofConsumerPriceIndex(CPI:ameasureoftheoverallcostofthegoodsandservicesboughtbyatypicalconsumer. HowtheConsumerPriceIndexisCalculated Table23-1 1. Fixthebasket. TheBureauofLaborStatisticsusessurveystodeterminearepresentativebundleofgoodsandservicespurchasedbya typicalconsumer. Example:4hotdogsand2hamburgers. Findtheprices. a. Pricesforeachofthegoodsandservicesinthebasketmustbedeterminedforeachtimeperiod.Example:Year20012002 2003 PriceofHot Dogs $1 $2 $3 PriceofHamburgers $2$3 $4
3.
Computethebasket’scost.
Harcourt,Inc.itemsandderiveditemscopyright2001byHarcourt,Inc.
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