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Consumer Price Index (CPI)
The overall cost of goods and services bought by a typical consumer.
Bureau of Labor Statistics (BLS)
The agency responsible for calculating and reporting the CPI in the United States.
Base year in CPI calculations
The benchmark year against which other years are compared.
Inflation rate calculation
Calculated as (CPI in 2021 - CPI in 2020) / CPI in 2020 × 100.
Substitution bias
Occurs when consumers switch to cheaper alternatives as prices change, which the CPI does not fully account for.
Largest component of the CPI basket
Housing, reflecting its significant share of consumer expenditures.
Core CPI
Excludes food and energy prices to provide a clearer picture of underlying inflation trends.
Producer Price Index (PPI)
Measures the average change over time in the selling prices received by domestic producers for their output.
CPI in the base year
Typically set to 100.
Problems with CPI
Includes substitution bias, introduction of new goods, and unmeasured quality change.
Inflation rate in 2021
10% when CPI in 2020 is 150 and in 2021 is 165.
Introduction of new goods
A problem with CPI that affects its accuracy.
Unmeasured quality change
A problem with CPI that affects its accuracy.
Overestimation of GDP
NOT a problem with the CPI.
Food and beverages in CPI
One of the components of the CPI basket, but not the largest.
Transportation in CPI
One of the components of the CPI basket, but not the largest.
Medical care in CPI
One of the components of the CPI basket, but not the largest.
Cost of goods and services bought by consumers
The cost of goods and services bought by consumers
Cost of goods and services bought by firms
The cost of goods and services bought by firms
Cost of housing
The cost of housing
Cost of healthcare
The cost of healthcare
PPI
The PPI measures the average change over time in the selling prices received by domestic producers for their output.
GDP deflator
The GDP deflator includes all goods and services produced domestically, including exports, while the CPI only includes goods and services consumed domestically.
CPI increase from 200 to 220
The inflation rate is calculated as 220−200/200 × 100 = 10%.
Real interest rate formula
Real interest rate = Nominal interest rate - Inflation rate
Indexation
Indexation involves adjusting payments, such as Social Security benefits, to account for changes in the cost of living, typically using the CPI.
Real interest rate when nominal is 8% and inflation is 3%
Real interest rate = Nominal interest rate−Inflation rate = 8% −3% = 5%.
Difference between CPI and GDP deflator
CPI includes imported goods, while GDP deflator does not.
CPI basket category
Government spending is not included in the CPI basket, which focuses on goods and services purchased by consumers.
Real interest rate with higher than expected inflation
If inflation is higher than expected, the real interest rate decreases because the nominal interest rate does not fully compensate for the higher inflation.
Purpose of the inflation rate
The purpose of the inflation rate is to measure the rate at which the general level of prices for goods and services is rising.
CPI
CPI measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
Nominal interest rate
The nominal interest rate is the stated interest rate on a loan or financial product, not adjusted for inflation.
Inflation rate calculation
The inflation rate is calculated by taking the difference between the new and old price level, dividing by the old price level, and multiplying by 100.
Exported goods in GDP deflator
Exported goods are included in the GDP deflator but not in the CPI.
Housing costs in CPI
Housing costs are included in the CPI as part of the basket of goods and services.
Food prices in CPI
Food prices are included in the CPI as part of the basket of goods and services consumed by households.
Transportation in CPI
Transportation is one of the categories included in the CPI basket.
Consumer goods in GDP deflator
The GDP deflator measures the prices of all goods and services produced domestically, not just consumer goods.
Inflation Rate
Measures changes in the cost of living by tracking the average price level of goods and services over time.
Unmeasured Quality Change
Refers to improvements in product quality that are not fully captured in price indices, such as better fuel efficiency in cars.
Formula for Converting Past Dollar Amounts
Amount in today's dollars = Amount in past dollars × (Price level today / Price level in past)
GDP Deflator
Reflects prices of all goods and services produced domestically, unlike the CPI, which uses a fixed basket of goods.
Primary Use of the CPI
To measure inflation by tracking changes in the cost of living for consumers.
Cost-of-Living Allowance (COLA)
Adjusts wages or benefits based on changes in the CPI to maintain purchasing power.
Inflation Rate Calculation
Calculated as (CPI current - CPI past) / CPI past × 100.
Reasons CPI Overstates Inflation
Includes substitution bias, introduction of new goods, and unmeasured quality changes, but not overestimation of GDP.
Real Interest Rate
Calculated by subtracting the inflation rate from the nominal interest rate.
Real interest rate
Real interest rate = Nominal interest rate − Inflation rate.
GDP deflator
It reflects prices of all goods and services produced domestically.
Consumer Price Index (CPI)
The CPI measures the overall cost of goods and services bought by a typical consumer.
Cost-of-living allowance (COLA)
A cost-of-living allowance (COLA) adjusts wages or benefits based on changes in the CPI to maintain purchasing power.
Inflation rate
The inflation rate is calculated as (CPI new - CPI old) / CPI old × 100.
Substitution bias
Substitution bias occurs when consumers switch to cheaper alternatives as prices change, but the CPI assumes a fixed basket of goods, overstating the cost of living.
Difference between CPI and GDP deflator
The CPI measures prices of goods and services bought by consumers, including imports, while the GDP deflator measures prices of all goods and services produced domestically, excluding imports.
Effect of new goods on CPI
The introduction of new goods increases consumer purchasing power, but the CPI does not immediately reflect this, leading to an overstatement of inflation.
Formula for calculating the real interest rate
Real interest rate = Nominal interest rate - Inflation rate.
Core CPI
The Core CPI excludes food and energy prices, which are volatile, providing a better measure of ongoing inflation trends.
Indexation
Indexation is the automatic adjustment of dollar amounts for inflation, used in wage contracts, Social Security benefits, and tax brackets.
CPI overstatement of inflation
The CPI overstates inflation due to substitution bias, the introduction of new goods, and unmeasured quality changes.
Producer Price Index (PPI)
The PPI measures the cost of goods and services bought by firms, and changes in the PPI often predict changes in the CPI.
Using CPI to compare dollar figures
The CPI is used to adjust past dollar amounts for inflation by multiplying the amount by the ratio of the current price level to the past price level.
Nominal interest rate
The nominal interest rate is the stated interest rate before taking inflation into account.
Inflation
Inflation is the rate at which the general level of prices for goods and services is rising.
Bureau of Labor Statistics
The Bureau of Labor Statistics is the principal fact-finding agency for the U.S. government in the broad field of labor economics and statistics.
Fixed basket of goods
A fixed basket of goods is a collection of products used to measure price changes over time.
Imported goods in GDP deflator
The GDP deflator does not include imported goods, focusing only on domestically produced items.
Cost of living
The cost of living refers to the amount of money needed to sustain a certain standard of living.
Purchasing power
Purchasing power is the financial ability to buy products and services.
