Consumer Price Index
A measure of the overall level of prices in the economy, and a measure of the cost of goods and services bought by a typical consumer
Three things to know about the Consumer Price Index
1. A basket of goods is chosen and fixed (quantities are kept constant so that you can see whats happening to prices)
2. Like the GDP Deflator, the CPI is sued to measure the infaltion rate (the percentage change in the level of prices) from year to year.
Cost of living allowance
Because prices are rising every year, employers pay an increasing wage to workers to offset the effects of inflation
What is the equation of CPI
CPI= Cost of the basket in current year prices/ cost of the basket in base year prices
What is the equation for inflation rate in year 2
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3 Problems in measuring cost of living using CPI
1. Substitution Bias
2. Introduction of New Goods
3. Unmeasured Quality Change
Substitute Bias
Consumers may switch to goods that have become relatively less expensive, causing the CPI to overstate inflation
Introduction of New Goods
CPI fails to account for new goods because the basket is fixed, so it may not really reflect what a typical consumer actually buys
Unmeasured Quality Change
It is difficult for CPI to account for changed in the quality of goods
Whats the difference between GDP Deflator and CPI if both measure price changes?
GDP deflator (the ratio of nominal GDP to Real GDP) reflects the prices of all goods and services PRODUCED in the country
CPI reflects the prices of goods and services BOUGHT by consumers based on a fixed basket
GDP Deflator includes investment and govern
Whats the formula for amount in today's dollars?
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Nominal interest rate
face-value interest rate (for example, when your bank says you will receive 5% annual interest on your savings)
Real Interest Rate
Interest rate corrected for the effects of inflation
The formula for Real Interest Rate
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How can you find nominal interest rate
You can use inflation rate in year 2 formula to calculate the nominal interest rate by using the dollar amounts in year 1 and year 2 instead of CPI
The consumer price index measure approximately the same economic phenomenon as
a. Nominal GDP
b. Real GDP
c. The GDP Deflator
d. The unemployment rate
c. The GDP Deflator
The largest component in the basket of goods and services used to compute the CPI is
a. Food and beverages
b. Housing
c. Medical Care
d. Apparel
b. Housing
If Pennsylvania gun manufacturer raises the price of rifles it sells to the US army, its price hikes will increase
a. Both the CPI and GDP deflator
b. Neither the CPI nor the GDP deflator
c. The CPI but not the GDP deflator
d. The GDP deflator but not the
d. The GDP deflator but not the CPI
Because consumers can sometimes substitute cheaper goods for those that have risen in price,
a. The CPI overstates inflation
b. The CPI understates inflation
c. The GDP deflator overstates inflation
d. the GDP deflator understates inflation
a. The CPI overstates inflation
If the consumer price index is 200 in year 1980 and 300 today, then $600 in 1980 has the same purchasing power as _________ today.
a. $400
b. $500
c. $700
d. $900
d. $900
You deposit $2,000 in a savings account, and a year later you have $2,100. Meanwhile, the consumer price index rises from 200 to 204. In this case, the nominal interest rate is _____ percent, and real interest rate is ____ percent.
a. 1,5
b. 3,5
c. 5,1
d.
d. 5,3