Measuring The Cost Of Living

Question 0

Producer prices index

Answer 0

Measure of the prices of a basket of goods and services bought by firms

Question 1

CPI

Answer 1

Measure of the overall prices of G and S bought by a typical consumer

Question 2

What are the 4 problems in measuring the cost of living?

Answer 2

1. Substitution bias
2. Introduction of new goods
3. Unmeasured quality change
4. Relevance of the cpi

Question 3

Substitution bias

Answer 3

Prices don’t change proportionately
–prices rise, demand falls
If price index = calculated assuming fixed basket of goods, it ignores poss of consumer sub. And overstates increase in cost of living

Question 4

Introduction of new goods

Answer 4

New goods = more variety
More variety= £s more valuable so need fewer £s to maintain given s.o.l
As cpi is based on fixed basket, doesn’t reflect change in purchasing power

Question 5

Unmeasured quality change

Answer 5

If quality decreases yearly, the effective value of the £ decreases, even if price stays same
Quality is hard to measure

Question 6

Relevance of cpi

Answer 6

People may not see reported cpi as relevant to their particular situation as spending patterns depend on the individual

Question 7

GDP deflator vs CPI

Answer 7

1. GDP deflator reflects prices of all G+S produced domestically
   CPI reflects prices of G+S bought by consumers
2. When price of oil increases, CPI increases by much more than GDP deflator