Chapter 8 - Measuring the Cost of Living Flashcards
If the CPI in 2011 is 1200, and in 2012 the CPI is 1260. What is the CPI based inflation rate in that country?
1260/1200 = 1.05
Therefore 5%
Because the CPI is based on a fixed based of goods and services, substitution bias causes the index to?
Overstate the increase in the cost of living from one year to the next.
An increase in the price of petrol imported into NZ will be reflected in?
The CPI but not the GDP Deflator
If the price of caviar goes up by 100% in 2011, but remains unchanged in 2012; and the price of bread is unchanged in 2011, but goes up by 10% in 2012. On the basis of these two products’ price changes, we would expect:
No impact on the CPI in 2011; a rise in the CPI in 2012
What tells you how fast the purchasing power of your bank account rises over time because of interest paid by the bank?
The real interest rate
What is the nominal interest rate?
The interest rate given without taking inflation into account. (This amount of interest the bank states)
Because CPI is based on a fixed basket of goods, the introduction of new goods in the economy causes the CPI to overestimate the cost of living. Why is this?
When a new good is introduced, it gives consumers greater choice, thus reducing the amount they must spend to maintain their standard of living
Do luxury goods affect the CPI of the GDP deflator?
No as an average house hold does not purchase luxury goods (e.g. caviar)
At the beginning of the year, Smith deposits $100 into his saving account which pays an annual interest rate of 5%. Inflation for the year is 10%. At the end of the year, Smith’s $100 has earned:
$5
As Smith has earned 5% of $100. However this $105 does not have the same purchasing power due to inflation
What does the GDP deflator and CPI measure?
How quickly prices are rising in an economy
What is the difference between the GDP Deflator and CPI?
- GDP Deflator reflects the prices of all goods and services produced domestically, some of which are not in the CPI basket of goods
- CPI measures reflects the cost of the basket of goods/services typically purchased by a consumer and will contain some things that the deflator does not (e.g. goods produced overseas)
- GDP D compares prices in the base year, while CPI compares prices of a fixed basket in different years
What is included in the CPI basket of goods/services?
Goods/services purchased by the typical consumer (NZs basket has over 690 items)
e.g. Food, health, transport, communication
What are the 3 reasons the CPI will be overstated?
1 - Substitution Bias: Basket does not reflect consumers buying cheaper substitute products
2 - Introduction of New Goods: New products of higher quality and/or lower price are not accounted for until they become commonplace
3 - Improved Quality of Goods: Over time technological advances increase the usefulness of products (e.g. Fuel efficiency)
What is the normal percentage that a CPI will be overstated by?
0.5-1.5%
What is the formula for calculating the CPI?
(Price of basket in current year / Price of basket in base year) x 100
