ECON 13 Lecture Notes - Lecture 5: Producer Price Index, Gdp Deflator, Real Interest Rate
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Document Summary
Different measures of inflation are based on different baskets of goods. The gdp deflator is based on a basket of goods representing everything in gdp. The producer price index is based on a basket of goods representing supplies and inputs bought by producers of goods and services. Over time, some prices rise faster than others. Consumers substitute toward goods that become relatively cheaper, mitigating the effects of price increases. The cpi misses this substitution because it uses a fixed basket of goods. The introduction of new goods increases variety, allows consumers to find products that more closely meet their needs. The cpi misses this effect because it uses a fixed basket of goods. Improvements in the quality of goods in the basket increase the value of each dollar. The bls tries to account for quality changes but probably misses some, as quality is hard to measure. Thus, the cpi overstates increases in the cost of living.
