Chapter 11: Measuring the Cost of Living

Question 1

Consumer Price Index (CPI)

Answer 1

a measure of the overall cost of the goods and services bought by a typical consumer

Question 2

CPI formula

Answer 2

(Price of basket of goods and services in current year * 100) / (Price of basket in base year)

Question 3

Inflation rate

Answer 3

the percentage change in price index from the preceding period

Question 4

producer price index

Answer 4

a measure of the cost of a basket of goods and services bought by firms

Question 5

What are the three problems in measuring the cost of living?

Answer 5

substitution bias: prices do not change proportionately from year to year

introduction of new goods: a new good increases variety, reducing the cost of maintaining the same level of economic well-being

unmeasured quality change: a change in quality changes the relative worth of a dollar

Question 6

Formula for amount in today’s dollars

Answer 6

Amount in year T dollars * (Price level today / Price level in year T)

Question 7

indexation

Answer 7

the automatic correction by law or contract of a dollar amount for the effects of inflation

Question 8

nominal interest rate

Answer 8

the interest rate as usually reported without a correction for the effects of inflation

Question 9

real interest rate

Answer 9

the interest rate corrected for the effects of inflation

Question 10

Formula for real interest rate

Answer 10

nominal interest rate - inflation rate