CPI - Consumer Price Index

What is price level?

a measure of the average prices of goods and services in the economy

What is producer price index

an average of the prices received by producers of goods and services at all stages of the production process

Biases with CPI

Substitution Bias
Increase in quality bias
New product bias
Outlet bias

What is the substitution bias?

consumers may change their purchasing habits away from goods that have increased in price

What is the Increase in quality bias

Products like cars and computers have become more durable and better quality over time. It is hard to isolate the pure-inflation part of price increases.

What is new product bias

a phenomenon where the introduction of new goods or services can lead to an overestimation of inflation and an underestimation of real economic growth. This bias arises when the price of new products is not adequately accounted for in traditional measures of inflation, such as the Consumer Price Index (CPI).

What is outlet bias

outlet bias might occur if the prices collected for the CPI are disproportionately weighted toward certain types of stores or outlets, while neglecting others.

What does BLS mean

Beaureau of Labour Statistics

How does the BLS reduce the size of CPI inflation rate

-Substitution and new product biases are addressed by updating the market basket every 2 years and smartphones every 6 months.
-Outlet bias is reduced through a point-of-purchase survey to track where consumers make their purchases.
-Quality bias is addressed using statistical methods.

-Prior to these changes, the total bias in the CPI was likely greater than 1 percentage point.

what is the difference between CPI and PPI

Like the CPI, the PPI tracks the prices of a market basket
of goods. But while the CPI tracks the prices of goods and
services purchased by a typical household, the PPI tracks
the prices firms receive for goods and services at all stages
of production. The PPI includes the prices of intermediate
goods, such as flour, yarn, steel, and lumber; and raw ma-
terials, such as raw cotton, coal, and crude petroleum.

What will happen to the prices of intermediate goods if they rise

If
the prices of these goods rise, the cost to firms of produc-
ing final goods and services will rise, which may lead firms
to increase the prices of goods and services purchased by
consumers. Changes in the PPI therefore can give an early
warning of future movements in the CPI.

What is nominal interest rate?

the stated interest rate on a loan

what is real interest rate

the nominal interest rate - inflation rate

It corrects the nominal interest rate for the effect of inflation on purchasing power

Why is real interest rate better?

it provides a better measure of the true cost of borrowing and the true return to lending than does the nominal interest rate

what is deflation?

the decline in the price level

Why do people dislike inflation?

It applies to the average person but not to every person - some people will find their incomes rising faster than the rate of inflation and so their purchasing power will rise or some incomes rise more slowly or not at all and their purchasing power will fall

payment. In that way, inflation can change the distribu-
tion of income in a manner that seems unfair to many
people.

What is the problem with anticipated inflation

-Workers know that unless their wages go
up by at least I0 percent per year, the real purchasing
power of their wages will fall.
- Businesses will be willing to
increase workers' wages enough to compensate for inflation because they know that the prices of the products
they sell will increase.
- Lenders will realize that the loans
they make will be paid back with dollars that are losing I0
percent of their value each year, so they will charge higher
interest rates to compensate.
-Borrowers will be willing to
pay the higher interest rates because they also know they
are paying back these loans with dollars that are losing
value.

Costs of Perfectly Anticipated Inflation

I. Inevitably, there will be a redistribution of income,
as some people's incomes fall behind even an anticipated level of inflation.
2. Firms and consumers have to hold some paper
money to facilitate their buying and selling.
Anyone holding paper money will find its purchas-
ing power decreasing each year by the rate of inflation. To avoid this cost, workers and firms will try
to hold as little paper money as possible, but they
will have to hold some.
3. Supermarkets and other stores that mark prices on
packages or on store shelves will have to devote
more time and labor to changing the marked
prices. The costs to firms of changing prices are
called menu costs 0; the term refers to the fact
that during times of significant inflation, restau-
rants have to reprint their menus more frequently.
4. taxes paid by investors will increase because inventors are taxed on the nominal payments they receive from owning stocks and bonds or from making loans rather than on the real payments

what are menu costs

the costs to firms of changing prices

how to calculate CPI

(cost of basket in current year/cost of basket in base year) x 100

Features of money

1. medium of exchange

2. store of value

3. a unit of account

4. a standard of deferred payment

What does M1 mean?

the amount of funds in current and checking deposits

categories of types of M1

cash+checking accounts+most saving accounts

what is nominal(or money ) price?

how many dollars it takes to buy an item

what is a real price

it removes inflation from a nominal price or interest rate

benefit of inflation?

helps borrowers repay loans because the dollars repaid in the future are worth less

calculation for real interest rate

nominal interest rate - inflation

what is the deflation method

it converts a nominal value from any year to base period values deflating is a version of the division method

Why would one care about the core CPI?

It removes particularly volatile CPI components from the regular CPI.

what is core CPI

Core CPI, or Core Consumer Price Index, is a measure of inflation that excludes certain items that are considered volatile and subject to short-term fluctuations.