Chapter 8 - The Cost of Living

Question 1

The Cost of Living

Answer 1

A large focus of macroeconomics is prices, but more importantly how changes in prices impact how much we can buy.

Prices change at different speeds across time and place.

Changing prices have effects on people’s incentives and choices.

• Price levels determine the relative value of salaries, savings and borrowing, and the relative cost of living in a different city.

Question 2

The Market Basket

Answer 2

The prices of many different goods and services must be considered when comparing the cost of living across time and place.

The market basket is a list of specific goods and services in fixed quantities.

• The goal is to use this to see how the cost of buying these goods and services changes over time and location.
• Items typically purchased by individuals.
• Keeping the quantities of each item constant ensures that changes only reflect price changes.

Question 3

A Price Index

Answer 3

Is a measure showing how much the cost of a market basket has changed relative to the cost in a base time period or location.

-Base year index is equalized to 100.

Question 4

Consumer Price Index (CPI)

Answer 4

Is a measure that tracks changes in the cost of a basket of goods and services purchased by a typical Canadian household.

• CPI is the most commonly used index tool for tracking changes in the cost of living in Canada
• The CPI is tracked by the Statistics Canada.
• The CPI measures the increase in the cost of the market basket relative to the cost in a given base year.

FORMULA

CPI = ((Cost of desired - year basket in desired - year prices) / (Cost of base - year basket in base year prices)) x 100

• The index always equals 100 in the BASE year
• The Index will be greater than 100 if the cost of the basket is greater than the base-year cost
• The index will be less than 100 if the cost of the basket is less than the base-year cost.

Question 5

Challenges in Measuring Price Changes

Answer 5

Two main challenges

1) Which goods should be included in the market basket?
- A single number cannot perfectly describe changes in the cost of living for everyone
2) Stats Canada tries to come up with a basket that represents a “typical” household
- The CPI basket is based on the average goods and services purchased by “urban consumers”
- One family’s cost of living could be different than that computed by the CPI - depends on what they purchase