Please enable JavaScript.
Coggle requires JavaScript to display documents.
Measuring the Cost of Living - Coggle Diagram
Measuring the Cost of Living
Inflation refers to a situation in which the economy’s overall price level is rising
The inflation rate is the percentage change in the price level from the previous period.
The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer
Inflation rate in 2 years=CPI in year 2-CPI in year 1/CPI in year 1
Compute the Basket’s Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times
GDP deflator= Norminal GDP
/Real GDP X 100
When the CPI rises, the typical family has to spend more dollars to maintain the same standard of living.
The CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living.
The CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living.
Unmeasured Quality Changes
If the quality of a good rises from one year to the next, the value of a dollar rises, even if the price of the good stays the same.
Introduction of New Goods
The basket does not reflect the change in purchasing power brought on by the introduction of new products.
Substitution Bias
The basket does not change to reflect consumer reaction to changes in relative prices.
The substitution bias, introduction of new goods, and unmeasured quality changes cause the CPI to overstate the true cost of living.
Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period.
Fix the Basket: Determine what prices are most important to the typical consumer
Find the Prices: Find the prices of each of the goods and services in the basket for each point in time
Choose a Base Year and Compute the Index:
Designate one year as the base year, making it the benchmark against which other years are compared
The DOS calculates other prices indexes
The producer price index, which measures the cost of a basket of goods and services bought by firms rather than consumers
The index for different regions within the country
Economists and policymakers monitor both the GDP deflator and the consumer price index to gauge how quickly prices are rising
The GDP deflator reflects the prices of all goods and services produced domestically, whereas
The consumer price index compares the price of a fixed basket of goods and services to the price of the basket in the base year (only occasionally does the DOS change the basket
Real and Nominal Interest Rates
Interest represents a payment in the future for a transfer of money in the past.
The real interest rate is the nominal interest rate that is corrected for the effects of inflation
The nominal interest rate is the interest rate usually reported and not corrected for inflation
When some dollar amount is automatically corrected for inflation by law or contract, the amount is said to be indexed for inflation