Ch. 8- Cost Of Living

Question 1

Market Basket

Answer 1

A list that includes specific goods and services, in fixed quantities for fixed items. Represents the typical purchases made by a consumer

Question 2

Price Index

Answer 2

Measures how much the cost of a market basket has changed relative to the cost at a base time period/location.

Question 3

CPI (Consumer Price Index)

Answer 3

The most commonly used index tool to track changes in cost of living via the market basket of a typical Canadian household.

Question 4

What are the 4 steps to calculating CPI and the Inflation Rate?

Answer 4

1) Determine the market basket
2) Find the prices and compute the cost of the market basket
3) Choose a base year and compute the index
4) Compute the inflation rate (using CPI)

Question 5

What are 2 reasons which explain why the market basket changes over time?

Answer 5

> Substitution- People switch between similar goods/services when relative prices shift.

> Innovation- As new goods/services become available, people change what they consume

Question 6

All Items Inflation (Headline Inflation)

Answer 6

Changes in prices for the entire basket of the average urban household

Question 7

Core Inflation

Answer 7

Price changes of the underlying trend in inflation

Question 8

What are the challenges in measuring price changes using CPI?

Answer 8

> CPI tries to balance out consumption of different types of people
Changes in prices, trends, innovation and substitution require updated goods and services to be measured
Updates undermine comparing a constant basket of goods and services

Question 9

Cost of Living Adjustments (COLAs)

Answer 9

Indexed payments that are indexed to inflation, so if CPI increases by a certain percentage, the benefits will also increase by that same percentage (ex. Canada Pension Plan)

Question 10

Indexing

Answer 10

Automatically increases payments in proportion to the cost of living (indexed to inflation)

Question 11

Producer Price Index (PPI)

Answer 11

Measures the prices of goods and services purchased by firms. It includes capital goods and raw materials that are usually not part of usual consumer baskets.

Question 12

Purchasing Power Parity (PPP)

Answer 12

Goods ought to cost the same everywhere after translating into common currency using foreign exchange rates.

Question 13

Give 3 reasons why Purchasing Power Parity may not hold

Answer 13

> Transaction Costs
Non-tradables
Trade Restrictions

Question 14

World Bank’s International Compensation Program (ICP) Index

Answer 14

Main measure used for international price comparisons. It uses a broad market basket that tries to represent the full cost of living across countries.

Question 15

PPP-adjustment (PPP-adjusted variables)

Answer 15

Recalculate economic statistics to account for differences in price levels across countries (ex. PPP-adjusted GDP)

Question 16

Purchasing Power Indexes

Answer 16

Find market basket of goods to compare across countries, then measure price of goods in each country. Finally, they build an index to show how much basket costs are in each country relative to a base.