chapter 11 measuring the cost of living. outline construction of cpi calculation of cpi and the...
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Chapter 11
Measuring the Cost of Living
Outline
Construction of CPICalculation of CPI and the Inflation RateProblems in measuring CPIGDP Deflator versus CPI Correcting economic variables for the
effects of inflationIndexationReal and Nominal interest rates
CPI The Consumer Price Index (CPI) is a measure
of the overall cost of the goods and services bought by a typical consumer.
CPI measures changes in the cost of living over time.
CPI estimates by how much incomes must rise to maintain a constant standard of living.
CPI reflects the purchasing power of the currency
It reports the movement of prices with an index number.
Calculating CPI: Various Steps
1. Fix the Basket: Identify the basket of goods consumed by a typical consumer
2. Find the Prices: Find the prices of each of the goods and services in the basket for each point in time
3. Compute the Basket’s Cost: Calculate the cost of the basket of goods and services at different times
4. Choose a base year and compute the index: Designate one year as the base year.
CPI= (price of basket in current year/ price of basket in base year)x100
Calculating CPI: Various Steps
5. Calculate the Inflation Rate: Use the CPI to calculate the inflation rate.
Inflation rate is the percentage change in the price index from the preceding period.
What’s in the CPI’s Basket?
Household10.0%
Food18.0%
Alcohol4.5%
Recreation10.4%
Clothing6.6%
Health4.3%
Transportation18.3%
Shelter27.9%
Canada Same month last yearPrevious month Nov-03
Change from previous month
Change from same month last year
1992 = 100 %
All items 120.8 122.4 122.7 0.2 1.6
Food 120.4 121.1 122.3 1 1.6
Shelter 115.7 118.2 118.3 0.1 2.2
Household operations and furnishings 114 115.1 114.9 -0.2 0.8
Clothing and footwear 105.2 105 104.2 -0.8 -1
Transportation 139.2 139.7 140.9 0.9 1.2
Health and personal care 116.2 117.7 118 0.3 1.5
Recreation, education and reading 126.7 128.3 127.5 -0.6 0.6
Alcoholic beverages and tobacco products 131.9 137 137.6 0.4 4.3
Special aggregates
All items excluding food 121 122.7 122.8 0.1 1.5
All items excluding energy 119.4 121.1 121.6 0.4 1.8
Energy 136.2 137 135.4 -1.2 -0.6
Source: Statistics Canada, CANSIM, table 326-0001 and Catalogue nos. 62-001-XPB and 62-010-XIB.
CPI Monthly Index: Nov 2003
Problems in Measuring The Cost of Living
The CPI is not a perfect measure of the “cost of living.”
Three reasons/problems:Substitution Bias: Consumers substitute toward
goods that have become relatively less expensiveIntroduction of new goods: With greater variety
consumers need fewer dollars to maintain any given standard of living
Unmeasured quality change: Quality impacts on the value of the currency
The Consumer Price Index versus the GDP Deflator
The CPI:includes only consumption goodsincludes the cost of importsis a fixed bundle of goods
The GDP Price Deflator:includes all final goods and servicesexcludes importsuses a current bundle of goods
Correcting Economic Variables for the Effects of Inflation
To convert (inflate) past wages and prices into current terms:
Current Year Dollars =
Past Year Nominal Value X [(Price index in current year) ÷ (Price index in past year)]
Correcting Economic Variables for the Effects of Inflation
To convert (deflate) current wages and prices into past year terms:
Value in Past Year Dollars =
Current Year Value X [(Price index in past year) ÷ (Price index in current year)]
Indexation
Indexation is the automatic correction of a dollar amount for the effects of inflation by law or contract. E.g., COLA
Real interest rate= Nominal interest rate- Inflation rate
Inflation in Canada: CPI inflation