Chapter 6 - good Flashcards
Consumer price index (CPI)
a measure that examines the weighted average of prices of a basket of consumer goods and services
Such as: transportation, food, medical care
How do you calculate CPI
It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.
What is the purpose of CPI
The CPI is used to measure inflation and reflect the cost of living.
What is inflation rate
The percentage change in the price level from one period to another.
How do you calculate the inflation rate
InflationRate= (CPIinYear2−CPIinYear1 / CPI in year 1)x 100
What is part of the CPI
- Fixing the basket
- Finding the prices
- Computing the basekt’s cost
- choosing a base year and computing the index
- computing the inflation rate
what is Indexation
The automatic adjustment of incomes or payments by an index to maintain purchasing power after inflation.
Define fixing the basket
Identify the items that consumers buy the most and determine their relative importance or weight in the total spending.
Define finding the prices
Collect data on the prices of each of the items in the fixed basket at different points in time.
Define computing the basket’s cost
Calculate the cost of the basket for each period.
Define choosing a base year and computing the index
The base year is the benchmark against which other years are compared. The index is then calculated using the formula:
CP = (Cost of basket in current year / cost of basket in base year ) x 100
What are the issues with the CPI
- substitution bias
- introduction of new goods
- unmeasured quality changes
Define substitution bias
Consumers may change their purchasing habits away from goods that have increased in price, but the CPI basket does not reflect these substitutions, leading to an overestimation of the cost of living.
Define introduction of new goods
The CPI basket may not promptly include new goods, which can result in an outdated measure that does not reflect the latest consumer preferences.
Define unmeasured quality changes
Improvements or declines in the quality of goods and services are not fully captured, leading to either overestimation or underestimation of the cost of living.
