Chapter 11 (CPI/Inflation) Flashcards
Inflation
A general increase in prices and fall in the purchasing value of money.
inflation rate
Measures the percentage change in prices over a period.
What is CPI
Consumer Price Index, measures a typical consumers cost of living
How do you calculate CPI
CPI = cost of basket in current year / cost of basket in base year X 100
Example: 680(current year cost) / 670 (base year cost) X 100 = 101.5
How do you calculate inflation rate
CPI this year - CPI last year / CPI Last year X 100
Example: 101.5 - 100 / 100 X 100 = 1.5%
Substitution Bias
The CPI assumes people do not change their purchasing habits when prices rise, but people may substitute expensive items for cheaper ones.
Quality Bias
The CPI doesn’t account for improvements in the quality of goods (e.g., a better laptop for the same price).
New Goods Bias
The CPI doesn’t immediately include new products in its basket, even though their prices can decrease quickly.
Outlet Bias:
It doesn’t account for changes in shopping behavior, such as buying from discount outlets.
What does CPI include and excludes and how often is it updated
Includes imports, excludes capital goods, and uses a fixed basket updated every 3 years.
What does GDP include and excludes and how often is it updated
Excludes imports, includes capital goods, and is continuously updated based on the current production.
What is the purpose of correcting inflation
To make sure you can compare values over time without inflation skewing the results.
Formula for adjusting inflation
Amount in base year dollars = Amount in given year * CPI in base year / CPI in given year
(base year is what you’re comparing the given year too )
Real Interest rate formula
nominal interest rate - expected inflation rate = real interest rate
