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consumer price index def
measure of the overlal cost of g&s bought by a typical consumer
how is cpi calulcated
survey consumers to determine fixed basket of goods
find price of good in each year (this should vary)
compute cost of basket of goods in each year (varied $*fixed q)
choose a base year
$ basket in current year / $ basket in base year * 100
how to use cpi to caluclate inflation rate
diff of cpi
(cpiy2 - cpiy1)/cpiy1 * 100%
producer price index def
measure of cost of basket of g&s by domestic firms
why is ppi importatn
elieved to be useful in predicting changes in cpi
bc firms respond to higher costs by making higher prices on products to consumers
us case study: what takes up the biggest portion of cpi basket
housing
transport
food and bev
medica
edu
recreation
apparel
other
**using a method similar to cpi => what do you do to the price and quantity
FIX THE QUANTITYYYYYYYY alter the price based on year
problmes of using cpi in measuring the cost of livign
substitution bias
intorudction of new goods
unmeasured quality change
overstatement of inflation rate
indexation
substitution bias def
when the price of one good changes, consumers often respond by subing another good in tis place
substituion bias ex
originaly the basket was 6 pears, 3 apples
but once apples price decrease, the basket becomes 3 pears, 6 apples (bc comsuners switch from mroe expesive to chepaer good)
this makes the cpi seem larger than it actually is
what is the result of sub bias
cpi IGNORES the sub effect
the sub bias offsets the rise in cost of livign due to inflation and the sub effect will not be AS serious if consumers CHANGE their demand
why is cpi bad in terms of sub bias
assuming a constant basket makes it so claculated inflation from cpi would OVERSTATE the actual rise of living costs
hwo does intro of new goods affect consumers and cpi
new goods offer consumers w more choices and the opporutnity to decrease costs of livign
intor new goods example
with the intorduction of whatsapp, people stop using mobile plans and sms messages, making the basket invalid
w cpi, they do not count the new goods that are introduced to the market -- does not accurate reflect the amount of satisfaction they get from their [roducts
how is intro of nw goods affect cpi and how does cpi affect intro new goods whatveer omg
demand of the product may decrease when new goods are introduced to the market
similar to sub bias
the new product has created teh chance for consumers tospend less while maintaining the same level of SATISFACTION
what does cpiu need to do to counter intro of new goods
the market based needs to be revised OFTEN ENOUGH
so that the cpi does not overstate the actual rise in costof liviing
what does unmeasured quality change mean
increase in cpi may be bc of inflation or improvement in product quality
example of unmeasured quality change
you paid 10% more for internet service
but the quality also improved
the real rise in price should be less than 105 hypothetically
why is unmeasured quality change hard to measure and bad for cpi
it is hard to measure a quantitative value of tbe benefit of changes in quality
stats dept attempts ot correct prices for quality changes but it is hard ot measue and prolly missed out ome
IT IS BAD FOR CPI bc people may unfairly lame the price increase to inflation
is cpi overstated or understated by hjow much
overstates
approx 1% per year
whta is indexation def
the automatic correction of dollar amount for effects of inflation by law / contract
what does indexed for inflation mean
your contract will be automatically adjusted every year according to changes in cpi
case study social security benefits
ss benefits are increased each year proprotional to the increase in cpi
oki and then what
if elderly consume same basketa s other people does ss benefits provide elderly w imporvement in sol?
yes
why does ss benefits and cpi result in imrpovement of sol for elderly
ss payments are tied to cpi
when cpi overstates actaul inflation
elderly (payees) are compensated (given) more than the inflation
making them be better off
but elderly might have diff consumption patterns compared to the regular consumer -- what do we do to combat this
may need to create a revised market basket for the elderly
e.g. one that places a hiehger weight on health care
gdp deflator vs cpi based on defs
gdp deflator: ratio of nominal gdp ot real gdp, comparing price of all goods 'currently produced' to the price of these goods in the base year
cpi: compares fixed basket of goods and services over time, comparing price of basket x in y1, 2, 3, to basket x in y0
gdp deflator vs cpi in simple terms
gdp deflator: changes basket
cpi: doesnt change basket
remind me what is nominal gdp formula
current products * current $
and what is real gdp?
current products * base year $
what is good about gdp deflator
COMPREHENSIVE measuee of level of domestic product prices in economy
what isgood aabout cpi
more REPRESENTATIVE in measruing price changes for gs bought by tuypical consumers
vv important!!!!!!!!!! therefore changes in prices of WHAT GOODS would affect cpi but not deflator
imported goods
bc they are not domestic products (therefore not in gdp)
and ARE bought by the typical consumer (therefore in cpi)
so will the inflation rate be the same when gdp deflator and cpi are both used
NOOOOOOOO
cpi caluclates inflation based on FIXED basket
while gdp deflator is based on CHANGING basket (depending on current domestic products)
how to calculate dollar values from one year to the nect
value in y2 dollar = value in y1 dollar / price level in y1 *price level in y2
what can price level be substituted by
cpi of respective years
what is the nominal interest rate
interest rate as usually reported without adjusting for any effect of inflation
real interest rate meanind
interest rate correct for effects of inflation
what is the formula for real interest rate
nominal interest rate - inflation rate of that year
for hk before covid, inflation rates were >1%
while after covid, nominal interest rates were <1%
what does that mean for rela interest rates
real interest rates were negative
what does real interest rates being negative mean for the purchasing power of money on deposit
purchasing power of money was falling each year
what did negative real interest rates mean for spending
When real interest rates are negative, the return on saving money is effectively less than the rate of inflation. This means that holding onto cash or keeping money in a savings account will cause its value to erode over time
people would AVOID saving too much money and focused on spending and investing on asssets
Consumers are better off spending or investing their money now rather than saving it, as saving would result in a loss of purchasing power. This behavior is driven by the expectation of higher future prices and the low returns on savings.
