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Lecture 11

lecture 11 ~ chapter 6.docx

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McMaster University
Hannah Holmes

Should I spend my money now or save it for a rainy day? Inflation- Comparing dollars from one time period to another Using CPI Example: your father earned $40000 in 1982. What is this salary worth in 2012 dollars? CPI 1982 = 61.8 CPI 2012 = 116.3 Answer: CPI  caluclations overstate the inflation rate  Indexing = Old Age Security; Canada Pension Plan  transfer paymets; only one is indexed not part of GDP o If it is indexed it means that the payment increases when the inflation increases Problems with CPI  There are 3 problems with CPI: (stem from the way we calculate it) 1. Substitution bias – ignores consumer substitution; overstates inflation a. Knows that people will buy oj if its $3 or 20$ 2. Introduction of new goods – CPI is based on a fix basket of goods and services; overstates inflation a. The way we fix the basket; refers mainly to computers, tvs, etc.. 3. Unmeasured quality change – some prices changes reflect quality improvements; overstates inflation a. Car; in 1982 $4000 in 2012 $40000  not the same car major improvements If none of these problems existsed the inflation rate would be lower Ex. For some racquet sports there have been increases in the size of racquets and the methods and materials used fore making them have improved. What problem in the construction of the CPI is this most relevant to?
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