Econ 101- ch 12

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10 Terms

1
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What does CPI measure?

The overall cost of goods and services bought by a typical consumer.

2
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Steps to calculate CPI

Fix basket → Find prices → Compute cost → Choose base year → Compute CPI → Compute inflation rate.

3
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Substitution bias

Consumers switch to cheaper goods; CPI overstates cost of living.

4
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New goods bias

More variety makes dollars more valuable; CPI overstates inflation.

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Unmeasured quality change

CPI fails to fully account for product quality improvements.

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Difference between CPI and GDP deflator

CPI includes imports; GDP deflator excludes them. CPI excludes capital goods; GDP deflator includes them.

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Formula to convert past to present value

Amount today = Amount past × (CPI today / CPI past).

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Indexation

Automatic inflation adjustment by law or contract (e.g., COLA, Social Security).

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Nominal interest rate

Interest rate not corrected for inflation.

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Real interest rate

Nominal rate minus inflation rate.