Macroeconomics Chapter 6 Measuring the cost of living

Consumer Price Index

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

Calculating the CPI

1. Determine the basket

2. find the prices

3. compute the basket cost

4. chose a base year and compute the index

   a) CPI = Price of basket and services in current year/ price of basket in base year x100

5. Compute inflation rate

   a) I.R Y2= CPI Y2- CPI Y1/CPI Y1 × 100

Inflation Rate

the percentage change in the price index from the preceding period

core inflation

a measure of the underlying trend of inflation

difference between GDP deflator and CPI

1. GDP reflects the prices of all goods and services produced domestically, whereas CPI reflects the prices of goods and services bought by consumer

2. the CPI compares the price of a fixed basket of goods and services to the price of the basket in the base year. By contrast the GDP deflator compares the price of currently produced goods and services to the prices of the same goods and services in the base year

because consumers can sometimes substitute cheaper goods for those that have risen in price

the CPI overstates inflation

Amount in today’s dollars

Amount in today’s dollars = amount in year T dollars x (price level today/price level in year T)

indexed

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

nominal interest rate

the interest rate as usually reported without a correction for the effects of inflation

real interest rate

the interest rate corrected for the effects of inflation

Real interest rate Equation

nominal interest rate - inflation rate

If the CPI is 200 for the year 1980 and 300 today, then $600 in 1980 has the same purchasing power ashas today.

$900

You deposit $2000 in a savings account, and a year later you have $2100. Meanwhile, the CPI rises from 200 to 204. In this case, the nominal interest rate is ___ percent, and the real interest rate is ___ percent.

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