Chapter 6.docx

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14 Apr 2012
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Chapter 6: Measuring the Cost of Living
Consumer price index, turning dollar figures into meaningful measure of purchasing power
o Used to monitor changes in the cost of living over time
o Consumer price index rises, a family has to spend more dollars to maintain the same
standard of living
Inflation: a situation in which the economy’s overall price level is rising
Inflation rate: percentage change in the price level from previous period
The Consumer Price Index
Consumer Price Index (CPI): measure of the overall cost of the goods and services bought by a
typical consumer
Each month it is reported
How the Consumer Price Index is Calculated
Use data on the prices of over 600 different goods and services
Steps
o Determine basket
Which prices are most import to the typical consumer
Eg, buy more hot dogs than hamburgers, price of hot dogs is more important,
given a greater weight
To know this give surveys
o Find the prices
Find the prices of each of the goods and services in the basket for each point in
time
o Compute the basket’s cost
Only prices in calculation change
Basket is kept the same, isolating effect o price changes from the effect and any
quantity changes that might be occurring at the same time
Multiply cost of the one item, and then by how many items there are
Then add all the items you have computed
You do this for every single year
o Choose a base year and compute the indexes
Base year = benchmark
Year that others are compared to
Each year, take the total basket of goods computed, then divide by base year
and then multiply by 100
This is the CPI!
CPI is always 100 in base year
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