U9: Measuring the Cost of Living: The Consumer Price Index (CPI)

What is CPI? What does it measure?

consumer price index measures the overall cost of goods and services typically purchased by an average consumer

What does a rise in CPI indicate?

that people generally have to spend more money to maintain the same standard of living they are used to

how do you calculate CPI?

current price total/base year total * 100

what are the base years for US CPI?

1982-1984

how do you calculate the inflation rate?

(new - original) / original

what are the eight divisions of CPI?

• food and drinks

• housing

• apparel

• transportation

• medical care

• recreation

• education and communication

• other goods and services

what does the producer price index measure?

the cost of a “basket” of goods/services typically purchased by businesses (raw materials, labor, etc.)

are costs of production factored into the final market value of a product?

yes

what do producer price indexes help predict?

changes in CPI - production cost increases are often “passed on” to consumers in the form of higher prices

what are some problems with the CPI?

• substitution bias

• introduction of new goods and services

• unmeasured quality changes

explain substitution bias

• substitution bias: prices don’t change at identical levels, so people often substitute cheaper alternatives

• CPI uses a fixed basket of goods/services - no substitution takes place

how is the introduction of new goods/services a problem for CPI?

more variety makes money more valuable

when suppliers compere for consumers’ business = prices tend to decrease, greater selection/quality of goods and services

why are unmeasured quality changes an issue for CPI?

prices go up, but so can quality

quality can really be measured by price