Macroeconomics Chapter 3: The CPI and the Cost of Living

Questions and Answers

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)

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

Inflation Bias

Price Effect

GDP Deflator Effect

Substitution Bias (correct)

Fix the basket Signup and view all the answers

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

It overstates the cost of living. Signup and view all the answers

It overstates the cost of living. Signup and view all the answers

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

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

Real interest rate = (nominal interest rate) - (inflation rate) Signup and view all the answers

Study Notes

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.

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.

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

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.

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 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.

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.