PEco Module 12

• The Consumer Price Index (CPI) is a measure of the overall level of prices and a measure of the overall cost of goods and services, bought by a typical consumer, computed and reported every month by the Bureau of Labor Statistics.
• The real interest rate is corrected for inflation and is computed by subtracting the inflation rate from the nominal interest rate.
• The CPI is used to make Cost of Living Adjustments and to correct economic variables for the effects of inflation.
• The Consumer Price Index (CPI) is used for measuring the cost of living and for adjusting dollar amounts from different years.
• The CPI differs from the GDP deflator in that it measures the cost of living, while the GDP deflator measures the change in the value of goods and services.
• The CPI can be used to compare dollar amounts from different years by correcting interest rates for inflation.
• The Consumer Price Index (CPI) is calculated by fixing the basket, finding the prices, computing the basket’s cost, choosing a base year and computing the CPI, and computing the inflation rate.
• The minimum wage in 1963 had more purchasing power than in 2013 when adjusted for inflation.
• The minimum wage was $1.25 in December 1963 and $7.25 in December 2013.
• The minimum wage in 1963 was $1.25 x 234.6/30.9 = $9.49 in 2013 dollars.
• They can then see how a variable has changed over time after correcting for inflation.
• Active Learning 4 involves expressing the 1990 tuition figures in 2015 dollars, then computing the percentage increase in real terms for all three types of schools.
• To compare, use CPI to convert 1963 figure into “2013 dollars”.
• Researchers, business analysts, and policymakers often use a technique to convert a time series of current-dollar (nominal) figures into constant-dollar (real) figures.
• The minimum wage was $1.25 in 1963 and $7.25 in 2013.
• The U.S Minimum Wage in Current Dollars and Today’s Dollars, 1960 – 2013.
• Comparing dollar figures from different times is harder due to inflation.
• Which type of school experienced the largest increase in real tuition costs?
• Each of these problems causes the CPI to overstate cost of living increases by about 0.5 percent per year.
• Armani raising the price of the Italian jeans it sells in the U.S causes the CPI to rise, but not the GDP deflator.
• The BLS has made technical adjustments, but the CPI probably still overstates inflation by about 0.5 percent per year.
• This matters if different prices are changing by different amounts.
• In each scenario, determine the effects on the CPI and the GDP deflator.
• Caterpillar raising the price of the industrial tractors it manufactures at its Illinois factory causes the GDP deflator to rise, but not the CPI.
• Social Security payments and many contracts have COLAs tied to the CPI.
• The CPI uses a fixed basket, while the GDP deflator uses a basket of currently produced goods & services.
• Starbucks raising the price of Frappuccinos causes both the CPI and the GDP deflator to rise.
• In 2016, households bought a CPI basket containing 5 pounds of beef and 25 pounds of chicken.
• The CPI misses this effect because it uses a fixed basket of goods.
• The percent increase in the cost of the 2016 household basket over 2015 – 2016, compared to the CPI inflation rate, was 17%.
• The cost of the CPI basket in 2016 was 100 x ($210/$120) = 175.
• The CPI in 2015 was 100 x ($150/$120) = 125.
• The CPI inflation rate from 2015 to 2016 was 13%.
• The cost of the 2016 household basket was $210.
• The CPI inflation rate from 2015 to 2016 was 40%.
• In 2014 and 2015, households bought a CPI basket containing 10 pounds of beef and 20 pounds of chicken.
• The cost of a basket containing 10 pounds of beef and 20 pounds of chicken was $120 in 2014, the base year.
• Substitution Bias is a problem with the CPI where over time, some prices rise faster than others, causing consumers to substitute toward goods that become relatively cheaper, mitigating the effects of price increases.
• Unmeasured Quality Change is a problem with the CPI where improvements in the quality of goods in the basket increase the value of each dollar, but the BLS tries to account for quality changes and probably misses some, as quality is hard to measure.
• The rate of increase in the cost of the household basket over 2015-2016, compared to the CPI inflation rate, is 30%.