Measuring the Cost of Living

Question 1

The consumer price index (CPI) helps

Answer 1

• Measure of the overall cost of goods and services bought by a typical consumer
• Monitor changes in the cost of living over time

Question 2

How the CPI is calculated in the US?

Answer 2

1. Fix the “basket”: surveying consumers to determine what’s in the typical consumer’s “shopping basket.”
2. Find the prices: collecting data on the prices of all the goods in the basket.
3. Compute the basket’s cost: using the prices to compute the total cost of the basket.
4. Chose a base year and compute the CPI
5. Compute the inflation rate

Question 3

Formula to calculate CPI is:

Answer 3

100 × (cost in current year/cost in base year)

Question 4

The formula to calculate inflation rate is (same with % change)

Answer 4

100 x (CPI this year - CPI last year)/ CPI last year

Question 5

Problems with the CPI are

Answer 5

1. Substitution bias, which arises because people substitute toward goods that have become relatively less expensive
2. The introduction of new goods, which are not reflected quickly in the CPI
3. Unmeasured quality change

Question 6

Differences between CPI and GDP deflator

Answer 6

Consumer price index measures the price of a fixed basket of goods and services purchased by a typical consumer relative to the same basket in the base year. The CPI differs from the GDP deflator
1. The CPI uses a fixed basket of goods over time while GDP changes its basket
2. The CPI includes foreign goods while GDP measures only domestic goods
3. The GDP deflator measures prices of all goods and services produced, whereas the CPI measures the prices of only the goods and services bought by consumers.