CH 8 : Measuring the Cost of Living

Question 1

Define Inflation

Answer 1

Persistent rise in the price levels in an economy.

Question 2

What is the CPI?

Answer 2

Consumer Price Index.

• Measure of overall cost of G/S consumer by a typical household.
• Measures purchasing power of the dollar.

Question 3

Calculating CPI?

Answer 3

(Basket in current year / Basket in base year) x 1000

Question 4

How to calculate inflation rate?

Answer 4

(CPI Y2) - (CPI Y1) / CPI Y1 x 100.

Question 5

Problems in using CPI?

Answer 5

1) Substitution Bias
- Consumers sub to goods that are relatively less expensive.
- CPI overstated.
2) Introduction of New Goods
- New products means greater variety.
- CPI overstated.
3) Unmeasured Quality Changes
- Increases in quality of a good are not measured.
- CPI overstated.

Question 6

GDP deflator vs CPI?

Answer 6

Deflator
- compares ratio of nominal to real.
- All G/S produced in country.
CPI
- Output at base year prices.
- Only typical goods.

Question 7

PPI?

Answer 7

Producer Price Index. Produced by firms rather than C. Good indication of CPI inflation though.

Question 8

What happens when CPI is overstated?

Answer 8

• Govt loses money, as wages are tied to inflation. Also superannuation + transfers.

Question 9

Define COLA

Answer 9

Cost of Living Allowance. Government doesn’t raise wages in response to inflation, instead pays out money to combat inflation. Tied to CPI.