Macroeconomics Chapter 3: The CPI and the Cost of Living
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Questions and Answers

What is the primary purpose of the Consumer Price Index (CPI)?

  • To determine the prices of a specific basket of goods
  • To calculate the GDP Deflator
  • To measure the overall cost of goods and services bought by firms
  • To monitor changes in the cost of living over time (correct)

    • What is the Core CPI?

  • A measure of the overall cost of consumer goods and services, excluding food and energy (correct)
  • A measure of the overall cost of consumer goods and services, including food and energy
  • A measure of the cost of a basket of goods and services bought by firms
  • A measure of the GDP Deflator

    • What is the problem with the CPI that arises because consumers substitute toward goods that become relatively cheaper?

  • Inflation Bias
  • Price Effect
  • GDP Deflator Effect
  • Substitution Bias (correct)

    • What is the first step in calculating the CPI?

    <p>Fix the basket</p> Signup and view all the answers

    What is the Producer Price Index (PPI)?

    <p>A measure of the cost of a basket of goods and services bought by firms</p> Signup and view all the answers

    What is the effect of the introduction of new goods on the CPI?

    <p>It overstates the cost of living.</p> Signup and view all the answers

    What is the effect of unmeasured quality change on the CPI?

    <p>It overstates the cost of living.</p> Signup and view all the answers

    What is the key difference between the CPI and the GDP deflator?

    <p>The CPI includes imported consumer goods, while the GDP deflator does not.</p> Signup and view all the answers

    What is the purpose of indexation?

    <p>To correct for inflation in labor contracts and government payments.</p> Signup and view all the answers

    What is the formula to calculate the real interest rate?

    <p>Real interest rate = (nominal interest rate) - (inflation rate)</p> Signup and view all the answers

    Study Notes

    The CPI and the Cost of Living

    • The Consumer Price Index (CPI) measures the overall cost of goods and services bought by a typical consumer.
    • It monitors changes in the cost of living over time.

    Calculating the CPI

    • The Bureau of Labor Statistics (BLS) surveys consumers to determine what's in the typical consumer's "shopping basket".
    • The BLS collects data on the prices of all the goods in the basket.
    • The total cost of the basket is computed using the prices.

    Core CPI

    • A measure of the overall cost of consumer goods and services, excluding food and energy.

    Producer Price Index (PPI)

    • A measure of the cost of a basket of goods and services bought by firms.

    Problems with the CPI

    • Substitution bias: consumers substitute towards goods that become relatively cheaper, mitigating the effects of price increases.
    • Introduction of new goods: the introduction of new goods increases variety, making dollars more valuable.
    • Unmeasured quality change: improvements in the quality of goods in the basket increase the value of each dollar.

    GDP Deflator vs. CPI

    • Imported consumer goods are included in CPI but excluded from GDP deflator.
    • Capital goods are excluded from CPI but included in GDP deflator (if produced domestically).
    • The basket: CPI uses a fixed basket, while GDP deflator uses prices of all goods and services currently produced domestically.

    Indexation

    • Indexation is a process where a dollar amount is automatically corrected for inflation by law or in a contract.
    • The increase in CPI determines the Cost of Living Adjustment (COLA) in many multi-year labor contracts, adjustments in Social Security payments, and federal income tax brackets.

    Real and Nominal Interest Rates

    • Nominal interest rate: the interest rate not corrected for inflation, measuring the rate of growth in the dollar value of a deposit or debt.
    • Real interest rate: the interest rate corrected for inflation, measuring the rate of growth in the purchasing power of a deposit or debt.
    • Real interest rate = nominal interest rate - inflation rate.

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    Description

    This quiz covers the consumer price index (CPI), its measurement, and its problems. It also distinguishes between CPI and GDP Deflator.

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