Chap 11, Mankiw - Measuring cost of living

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Chap 11, Mankiw - Measuring cost of living

• The price indices consumer, producer
• Issues related to the measurement of cost of
  living
• Adjusting variables for the rate of inflation

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• The price indices
• the consumer price index (CPI)
• the producer price index (PPI)
• steps in calculating CPI and measuring cost
• 1.
• 2.
• 3.
• 4.
• 5.

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Calculating the Consumer Price Index and the
Inflation Rate An Example
Step 1Survey Consumers to Determine a Fixed
Basket of Goods
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Calculating the Consumer Price Index and the
Inflation Rate An Example
Step 2 Find the Price of Each Good in Each Year
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Calculating the Consumer Price Index and the
Inflation Rate An Example
Step 3 Compute the Cost of the Basket of Goods
in Each Year
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Calculating the Consumer Price Index and the
Inflation Rate An Example
Step 4 Choose One Year as the Base Year (2001)
and Compute the Consumer Price Index in Each Year
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Calculating the Consumer Price Index and the
Inflation Rate An Example
Step 5 Use the Consumer Price Index to Compute
the Inflation Rate from Previous Year
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Whats in the CPIs Basket?
5
5
6
5
6
40
17
16
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• II. Issues in the measurement of cost of living
• A. Problems in constructing the CPI
• Substitution bias
• Consumers substitute toward goods
  
• and away
• The basket
  
  The index _____________ the increase in cost
  of living by not considering consumer
  substitution.
• ex

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• 2. Introduction of new goods
• The basket
  
  New products result in
  , which in turn makes each dollar
  
• ex
• 3. Unmeasured quality change
• If the quality of a good rises from one year to
  the next, the value of a dollar , even
  if the price of the good
  .
• By not
• ex

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• B. The GDP Deflator versus the Consumer Price
  Index
• Both the GDP deflator and the consumer price
  index measures how quickly prices are rising -
  two important differences between the two,
• 1. The GDP deflator reflects the prices of all
  goods and services
• and
  includes
• The CPI reflects the prices of all goods and
  services
• 2. The CPI compares the price of a fixed basket
  of goods services
• The GDP deflator compares the price of
  currently

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Two Measures of Inflation
Percent
per Year
15
10
5
0
2000
1965
1970
1975
1980
1985
1990
1995
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III. Correcting for effects of inflation deflating
dollar figures from different times salary in
2006 dollars salary in 2000 dollars x Suppose
US economy has a 3 inflation rate. If the CPI
for 2000 is 100, (price level in 2006/price level
in 2000) A person getting 50,000 in 2000 must
get today,
in order to enjoy the same standard of
living indexation of contracts The above formula
is very often used to write salary or other
financial contracts real and nominal interest
rates Real interest rate nominal interest rate
inflation rate
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Real and Nominal Interest Rates
Interest Rates (percent per year)
15
10
5
0
-5
1998
1965
1970
1975
1980
1985
1990
1995