mankiw macroeconomics ch 24

consumer price index (CPI)

measure of the overall cost of goods and services bought by a typical consumer; measures typical consumer's cost of living

inflation rate

percentage change in price index from preceding period

producer price index

measure of cost of a basket of goods and services bought by firms

indexation

automatic correction by law or contract of a dollar amount for the effects of inflation

nominal interest rate

interest rate as usually reported without a correction for the effects of inflation; rate of growth in the dollar value of a deposit or debt

real interest rate

interest rate corrected for effects of inflation; rate of growth in the purchasing power of a deposit or debt

inflation

situation in which economy's overall price level is rising

substitution bias

over time, some prices rise faster than others; consumers substitute towards good that are relatively cheaper, mitigating the effects of the price increases, missed by CPI because it uses a fixed basket of goods - CPI overstates increases in cost of living (problem with CPI)

introduction of new goods

increases variety, allows consumers to find products that more closely meet their needs; dollars become more valuable; CPI misses this because it uses a fixed basket of goods - CPI overstates increases in cost of living (problem with CPI)

unmeasured quality change (improvement)

increases value of each dollar; BLS tries to account for quality changes but misses some, as quality is hard to measure - CPI overstates increases in cost of living

imported consumer goods

included in CPI, excluded from GDP deflator

capital goods

excluded from CPI, included in GDP deflator (if produced domestically)

correcting for inflation

amount in today's dollars = amount in year, T, dollars x (price level today/price level in year T)