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Chapter 5

Econ 1BB3 - Chapter 5 CPI&Interest Rate.docx

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Department
Economics
Course
ECON 1BB3
Professor
Bridget O' Shaughnessy
Semester
Winter

Description
Monday, January 28, 2013 Econ 1BB3 – CPI & Interest Rate Using CPI  Example: Your father earned $40,000 earned in 1982. What is this salary worth in 2012 dollars? o CPI (1982) = 61.8 o CPI (2012) = 116.3 o Base year CPI is always 100 o Answer: 116.3/61.8 = x/40 000 o X = 116.3 x 40 000 / 61.8 = $75 275 Problems with CPI Indexing  1. Substitution Bias – Ignores consumer substitution; overstates inflation  2. Introduction of new Goods - CPI is based on a fix basket of goods and services; overstates inflation. Explanation of why TV prices plummet after a few years  3. Unmeasured quality change – some prices changes reflect quality improvements; overstates inflation CPI vs GDP Deflator  1. CPI – Goods and services bought by typical consumers.  GDP deflator – reflects prices of all goods and services produced domestically.  2. CPI – Price change, quantities stay fixed  GDP deflator – quantities change, price stay fixed  Ration  cost of basket current year / cost of basket base year (CPI)
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