ECON 2105 Lecture 5: The Cost of Living and Living with Inflation

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ECON 2105 - Lecture 5: The Cost of Living and Living with Inflation
Cost of Living and CPI
-If cost of living rises slower than your income, your standard of living will improve
-If cost of living rises faster than your income, your standard of living will fall
-U.S. cost of living rose about 2% over the last year
-Cost of living is measured by the Consumer Price Index (CPI)
Announced monthly by the Department of Labor’s Bureau of Labor Statistics (BLS)
-Index: expressed as a percentage of the value in a base period
CPI measures cost of living relative to a base period
CPI is 100 in base period 1982-84, in December 2016 it was about 241.43, meaning that
cost of living is 241.43% of 1982-84 value
-CPI construction: cost of “market basket” of goods and services purchased by an average
“representative” urban household
Market basket updated every two years and established through surveys
BLS re-prices the market basket monthly
CPI is the cost today divided by the cost in 1982-84
-Biases in the CPI:
Assumes market basket from 2013-2014 in 2017, but in reality consumers will substitute
away from costly goods
Slow to recognize new products (takes up to 3 years)
Hard to measure quality improvements
-CPI in December 2016 was 241.43, 229.104 in July 2012 (an increase of 5.38%)
If your salary rose 8% over the last four and a half years, you have a higher standard of
living, but not 8% higher
-To determine how much higher, must understand real income
Real Income: the purchasing power of your income
-How many market baskets can it buy?
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Divide your salary by the CPI = real income
Called “deflating”
-Economists distinguish between current dollar/nominal income and real income
-If your salary was $100,000 in July 2012 and $108,000 in December 2016:
Approximate change in real income: % change of real = (%change of nominal - %change in
CPI)
8% - 5.4% = 2.6% approximate change in real income
Inflation
-U.S. inflation history: high in the 1970s
-Wages in manufacturing
Nominal wage in 1950 was $1.40/hour, rose to over $20 in 2016 (blue line)
-Real wage peaked in mid 1970s (red line)
-Inflation is not the cause of wage stagnation
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