5. Measuring the Cost of Living

Question 1

what is the consumer price index

Answer 1

the measure of the overall cost of goods and services bought by a typical househould

Question 2

what does the cost of living show?

Answer 2

shows the purchasing power of money of the typical consumer

Question 3

4 steps to calculate CPI

Answer 3

1. fix basket - determine most important goods and services
2. find the prices
3. compute the basket’s cost
4. (choose base year) CPI = price of basket in current year/price of basket in base year x 100

Question 4

calculate inflation rate

Answer 4

(CPI of second year - CPI of first year)/CPI of first year x 100

Question 5

problems of CPI

Answer 5

substitution bias, overstates the increase in price as consumers go for substitutes.

introduction of new goods increases each dollar’s value as consumers need fewer dollars to maintain any given standard of living

unmeasured quality changes, increase in quality increases dollar even if price stays the same

OVERALL OVERSTATES TRUE INFLATION

Question 6

Calculate the wage of a 1905 brick layer in today’s dollars

Answer 6

(price level of 2015/price level in 1905) x wage in 1905 dollars

Question 7

What is indexation?

Answer 7

When some dollar amount is automatically corrected for inflation by law or contract (ie salary increased by x% every year to account for inflation)

Question 8

What is COLA

Answer 8

Cost of living allowance: indexation of the wage to the CPI. When CPI rises it automatically raises the wage. BUT THE WAGE ITSELF DOES NOT CHANGE, COLA is just added on.

Question 9

what is the nominal interest rate?

Answer 9

the interest rate that is reported

Question 10

what is the real interest rate?

Answer 10

it is the nominal interest that is corrected for the effects of inflation. Nominal interest rate minus inflation rate.

Question 11

WHATS THE ONLY THING THAT MATTERS ABOUT MONEY AND GDP AND SHIT

Answer 11

PURCHASING POWER, NOT THE NUMBERS