Chapter 16 Flashcards
Consumer Price Index
A measure of the overall cost of goods and services bought by a typical consumer
Core CPI
A measure of the overall cost of consumer goods and services excluding food and energy
Inflation Rate
the percentage change in the price index from the preceding period
Producer Price Index
A measure of the cost of a basket of goods and services bought by firms
Indexed
The automatic correction by law or contract of a dollar amount for the effects of inflation
Real Interest Rate
the interest rate corrected for the effects of inflation
Nominal Interest Rate
the interest rate as usually reported without a correction for the effects of inflation
Indexation
the automatic correction by law of contract of a dollar amount for the effects of inflation
CPI Formula
Price of basket of goods and services in current year/ Price of basket in base year x 100
Compute the inflation rate-use the CPI to calculate the inflation rate, which is the percentage change in the price index from the proceeding period.
Inflation rate in year 2=CPI in year 2-CPI in year 1/CPI in year 1 x 100
Typical basket of goods and services
- Housing
- Transportation
- Food and beverages
- Medical care
- Education and communication
- Recreation
- Apparel
- Other goods and services
3 problems with CPI
- Substitution bias
- Introduction of new goods
- Unmeasured quality change
Substitution Bias
When prices change from one year to the next, they do not all change proportionately. Some prices rise more than others. Consumers respond by buying less of goods whose prices have risen and more of the goods whose prices have risen less or fallen.
Introduction of new goods
When a new good is introduced, consumers have more variety from which to choose, and this increased variety in turn reduces the cost of maintaining the same level of economic well-being.
Unmeasured quality change
If the quality of a good begins to deteriorate from one year to the next while its price remains the same, you are getting a lesser good for the same amount of money, so the value of the dollar falls. Similarly, if the quality rises from one year to the next, the value of a dollar rises.
