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1、Copyright2004 South-Western24Measuring the Cost of Living Copyright2004 South-WesternMeasuring the Cost of Living InflationInflation refers to a situation in which the economys overall price level is rising. The inflation rateinflation rate is the percentage change in the price level from the previo
2、us period.Copyright2004 South-WesternTHE CONSUMER PRICE INDEX The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer. The Bureau of Labor Statistics reports the CPI each month. It is used to monitor changes in the cost of living over ti
3、me.Copyright2004 South-WesternTHE CONSUMER PRICE INDEX When the CPI rises, the typical family has to spend more dollars to maintain the same standard of living.Copyright2004 South-WesternHow the Consumer Price Index Is Calculated Fix the Basket: Determine what prices are most important to the typica
4、l consumer. The Bureau of Labor Statistics (BLS) identifies a market basket of goods and services the typical consumer buys. The BLS conducts monthly consumer surveys to set the weights for the prices of those goods and services.Copyright2004 South-WesternHow the Consumer Price Index Is Calculated F
5、ind the Prices: Find the prices of each of the goods and services in the basket for each point in time.Copyright2004 South-WesternHow the Consumer Price Index Is Calculated Compute the Baskets Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times.C
6、opyright2004 South-WesternHow the Consumer Price Index Is Calculated Choose a Base Year and Compute the Index: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. Compute the index by dividing the price of the
7、basket in one year by the price in the base year and multiplying by 100. Copyright2004 South-WesternHow the Consumer Price Index Is Calculated Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period.Copyright2004 South-WesternHow the Consu
8、mer Price Index Is Calculated The Inflation Rate The inflation rate is calculated as follows:Table 1 Calculating the Consumer Price Index and the Inflation Rate: An ExampleCopyright2004 South-WesternTable 1 Calculating the Consumer Price Index and the Inflation Rate: An ExampleCopyright2004 South-We
9、sternTable 1 Calculating the Consumer Price Index and the Inflation Rate: An ExampleCopyright2004 South-WesternTable 1 Calculating the Consumer Price Index and the Inflation Rate: An ExampleCopyright2004 South-WesternTable 1 Calculating the Consumer Price Index and the Inflation Rate: An ExampleCopy
10、right2004 South-WesternCopyright2004 South-WesternHow the Consumer Price Index Is Calculated Calculating the Consumer Price Index and the Inflation Rate: Another Example Base Year is 2002. Basket of goods in 2002 costs $1,200. The same basket in 2004 costs $1,236. CPI = ($1,236/$1,200) 100 = 103. Pr
11、ices increased 3 percent between 2002 and 2004.FYI: Whats in the CPIs Basket?16% Food and beverages17% TransportationMedical care6%Recreation6%Apparel4%Other goods and services4%41% Housing6%Education and communicationCopyright2004 South-WesternCopyright2004 South-WesternProblems in Measuring the Co
12、st 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.Copyright2004 South-WesternProblems in Measuring the Cost of Living Substitution bias Introduction of new goods Unmeasured quality changesCopyright
13、2004 South-WesternProblems in Measuring the Cost of Living Substitution Bias The basket does not change to reflect consumer reaction to changes in relative prices. Consumers substitute toward goods that have become relatively less expensive. The index overstates the increase in cost of living by not
14、 considering consumer substitution.Copyright2004 South-WesternProblems in Measuring the Cost of Living Introduction of New Goods The basket does not reflect the change in purchasing power brought on by the introduction of new products. New products result in greater variety, which in turn makes each
15、 dollar more valuable. Consumers need fewer dollars to maintain any given standard of living.Copyright2004 South-WesternProblems in Measuring 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
16、good stays the same. If the quality of a good falls from one year to the next, the value of a dollar falls, even if the price of the good stays the same. The BLS tries to adjust the price for constant quality, but such differences are hard to measure.Copyright2004 South-WesternProblems in Measuring the Cost of Living The substi
