Econ - Chapter 11: Measuring the cost of living

Question 1

Inflation

Answer 1

refers to a situation in which the economy’s overall price level is rising

Question 2

Deflation

Answer 2

when overall price level is falling

Question 3

How is inflation computed

Answer 3

Percentage change = (final -initial) initial
- uses the price index

Question 4

Consumer Price Index (CPI)

Answer 4

measure of overall goods and services bought by a typical consumer
- reported by Bureau of Labor Statistics every month
- used to monitor changes in the cost of living over time

Question 5

What does it mean when CPI increases

Answer 5

families need to spend more to maintain the same level of standard of living

Question 6

How is CPI calculated?

Answer 6

Step 1: Fix the basket
Step 2: Find the prices
Step 3: Compute the basket’s cost
Step 4: Choose a base year and compute the index

Question 7

Step 1: Fix the basjet

Answer 7

• What goods and services are most important for typical consumer?
• BLS identities a market basket of goods and services the typical consumer buys

Question 8

Step 2: Find the price

Answer 8

Find the price of goods and service in the basket for each point in time

Question 9

Step 3: Compute the basket’s cost

Answer 9

use the data on prices to calculate the cost of the basket of goods and services at different times

Question 10

Step 4: Chose a base year and compute the index

Answer 10

• Designate 1 year as the base year
• Divide price of basket in 1 year by price in base year
  CPI (year) = Price of basket(year)/ Price of basket(base year)

Question 11

Problems with CPI

Answer 11

Since it is a fixed basket:
- substation bias
- introduction of new goods
- unmeasured quality changes
Therefore CPI is likely to overstate inflation

Question 12

How to convert dollar values from year T into base year dollars

Answer 12

Amt(base yr) = Amt (yr T)/Price index (yr T)

Question 13

Difference between CPI and GDP deflator

Answer 13

GDP deflator: reflects price of all goods and services produced domestically
CPI: reflects price of goods and services bought by cosumers

Question 14

Imported consumer goods (indexes)

Answer 14

included in CPI, excluded from GDP deflator

Question 15

Capital goods (indexes)

Answer 15

excluded from CPI, included in GDP deflator

Question 16

The basket of CPI

Answer 16

fixed basket

Question 17

The basket of GDP deflator

Answer 17

basket of currently produced goods and services

Question 18

Nominal Interest Rate (i)

Answer 18

• not correct for inflation
• growth rate of the dollar value of deposit/ debt

Question 19

Real Interest Rate (r)

Answer 19

• interest rate corrected for inflation
• growth rate of purchasing power of deposit/ debt

Question 20

Interest relationship

Answer 20

r = i - inflation rate