Chapter 6.docx

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10 Apr 2012
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Chapter 6
Govt spending is exogenous and GDP that is the endogenous
Exogenous variables changes affect the changes in endogenous variables
Consumers Price Index (CPI)- measures the typical consumers cost of living
5 Steps of calculating CPI
-Determine the basket: stats Canada surveys what consumers buy
-Find the prices: data on prices of all the goods in basket
-Compute the basket’s cost: use data on prices to compute the total cost of the basket
-Choose a base year and compute the index: cost of basket in current year/cost of basket
in base year
-Compute the Inflation Rate: Inflation rate= Percentage change in CPI from year to year:
CPI this year CPI last year/CPI last year
EXAMPLE: Chapter 6 Slide 7
The CPI in the base year is always 100
Commodity Substitution Bias- The CPI overstates increases in the cost of living
Introduction to New Goods- increase in variety therefore the consumer has options to
find products that are closer to meet their needs
Unmeasured Quality Change- Improvements in the quality of goods in the basket
increase the value of each dollar, the CPI overstates increases in the cost of living
Problems with the CPI- all the problems cause the CPI to overstate cost of living
increases
Two ways of measuring standard of living is using the GDP deflator and the CPI
DIFFERENCES of CPI vs. GDP Chapter 6 Slide 21
Nominal is greater than Real which means there is inflation
Real is greater than Nominal which means there is deflation
Simple Interest
Future Value of Money =Amount of payment(1+interest rate)^number of years
Present Value =Future Value/(1+interest rate)^Number of years
If present value is greater than the cost then you invest
If present value is less than cost than you don’t invest
If present value is = to the cost than it is indifferent
The rule of 70=70/interest rate number
If you are risk averse the expected value of certainty is greater than the expected value of
a gamble
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