Cost of Living, Price Levels, Inflation

Flashcards about cost of living and price levels.

Cost of Living

How much money people need to maintain a certain standard of living, based on the goods and services they can afford.

Inflation

A situation in which the economy’s overall price level is rising

Inflation Rate

The percentage change in the price level from the previous period

Consumer Price Index (CPI)

Measures the overall cost of the goods and services bought by a typical consumer

Office of National Statistics (ONS)

identifies a market basket of goods and services the typical consumer buys and conducts regular consumer surveys to set the weights for the prices of those goods and services.

First stage to calculating CPI: Fix the Basket

Determine what prices are most important to the typical consumer

Second stage to calculating CPI: Find the Prices

Find the prices of each of the goods and services in the basket for each point in time.

Third stage to calculating CPI: Compute the Basket’s Cost

Use the data on prices to calculate the cost of the basket of goods and services at different times.

Fourth stage to calculating CPI: Choose a Base Year and Compute the Index

Designate one year as the base year, making it the benchmark against which other years are compared and compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100.

Fifth stage to calculating CPI: Compute the inflation rate

The percentage change in the price index from the preceding period.

Swiss CPI – LIK (Landesindex für Konsumentenpreise)

Tracks prices of approximately 1,050 goods and services for private households, tracking around 30,000 prices per month in 12 regions with a total of around 2,200 outlets, and conducts a monthly survey of approximately 300 households.

Producer Price Index

A measure of the cost of a basket of goods and services bought by firms, which can be helpful in predicting changes in the CPI.

Three key issues that cause the CPI to overstate the true cost of living

Substitution bias, introduction of new goods, and unmeasured quality changes.

Substitution Bias

The basket does not change to reflect consumer reaction to changes in relative prices; consumers substitute toward goods that have become relatively less expensive; the index overstates the increase in cost of living by not considering consumer substitution.

Introduction of New Goods

The basket does not reflect the change in purchasing power brought on by the introduction of new products; new products result in greater variety, which in turn makes each euro more valuable; consumers need less money to maintain any given standard of living.

Unmeasured Quality Changes

If the quality of a good rises, this is effectively a rise in the value, even if the price stays the same; if the quality of a good falls, the value falls, even if the price stays the same; statistically offices try to adjust the price for constant quality, but such differences are hard to measure.

GDP deflator

Nominal GDP divided by Real GDP, multiplied by 100.

GDP deflator

Reflects the prices of all goods and services produced domestically.

Consumer Price Index

Reflects the prices of all goods and services bought by consumers.

Consumer Price Index

Compares the price of a fixed basket of goods and services to the price of the basket in the base year.

GDP deflator

Compares the price of currently produced goods and services to the price of the same goods and services in the base year.

Price indexes

Used to correct for the effects of inflation when comparing money figures from different times.

Indexation

When some money amount is automatically corrected for inflation by law or contract.

Nominal Interest Rate

The interest rate usually reported and not corrected for inflation.

Real Interest Rate

The nominal interest rate that is corrected for the effects of inflation.