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Chapter 6 Study Notes / Summary These are notes made based on the chapter in the book that the course uses - very helpful, covers every little section of chapter and holds important points.

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ECON 102
Jing Ye Shi

Chapter 6 – Measuring the Cost of Living Introduction  the prices of nearly all goods and services have been increasing over time, but so have people’s incomes  economists measure overall cost of living using CPI  also to compare prices now with those in the past, the consumer price index (CPI) is used  CPI is used to monitor changes in the cost of living over time  if CPI increases, the typical family has to spend more to maintain the same standard of living  inflation is used to describe when the overall price level in the economy is rising  inflation rate refers to the percentage change in price level from a previous period The Consumer Price Index  CPI is a measure of the overall cost of goods and services bought by a typical customer How CPI is Calculated 1. Determine the basket: determine what prices are most important to the typical consumer a. if buying more hot dogs that hamburgers, then price of hotdogs is more important and is given more weight b. weights are set by surveying consumers and finding the basket of goods and services that a typical consumer buys 2. Find the prices: find the prices of each goods and services in the basket for each point in time 3. Compute the basket’s cost: use the data on prices to calculate the cost of basket at different times 4. Choose a base year and compute the index: designate a base year, compute using: 1. 100 * cost of basket in current year/ = CPI 2. cost of basket in base year b = CPI 5. Compute the inflation rate: percentage change in the price index from preceding period 1. CPI this year – CPI last year/ * 100% = inflation rate 2. CPI last year = inflation rate Core inflation – the measure of the underlying trend of inflation; excludes the most volatile components from the CPI basket of goods and services CPI Other  CPI is also calculated on other indexes:  CPI for each province  16 cities  food  clothing  core inflation (see above) Problems in Measuring the Cost of Living  the consumer price index is not a perfect measure of the cost of living  three problems with the index are widely acknowledged but difficult to solve: substitution bias, introduction of new goods and unmeasured quality changes  Substitution Bias o prices change from year to year, but not all proportionally, some rise more than others o consumers respond by substituting towards goods that become cheaper or rise by a little o because the CPI is a fixed basket, the CPI misses this substitution and overstates increases in the cost of living  Introduction of New Goods o when a new good is introduced, consumers have more variety from which to choose o greater variety has the ef
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