Consumer Price Index

What does CPI measure?

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

How to measure CPI

CPI= new basket cost/ base year basket cost

How do you determine basket cost?

(price x quantity) + (price x quantity)

How does CPI differ from GDP? 1st Way

CPI holds quantity fixed while GDP holds price fixed

How do you calculate inflation using CPI?

Inflation= (new CPI - old CPI)/old CPI

Substitution Bias

Consumers respond to price changes by buying less of a more expensive good and more of a cheaper good. This overstates the increase in CPI and increase in inflation.

Introduction of New Goods

As new goods are introduced into the economy. consumers have more choices and each dollar is worth more.

Unmeasured Quality Change

if the quality of a good deteriorates from one year to the next while its price remains the same, the value of a dollar falls, because you are getting a lesser good for the same amount of money

How does CPI differ from GDP? 2nd Way

The GDP deflator reflects the prices of all goods and services produced domestically, whereas the CPI reflects the prices of all goods and services bought by consumers

What happens if the price of Boeing airplane is sold to the air force increases?

- GDP deflator increase

- CPI stays the same

What happens if the price of a Lambo increases

- GDP stays the same

- CPI increases

How do you calculate amount in todays dollars?

amount in year T dollars x (CPI today/CPI in year T)

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