Measuring the Cost of Living (Consumer Price Index) - Economics PDF

MEASURING THE COST OF LIVING Chapter 6 Copyright © 2020 by Nelson Education Ltd. 6-1  THE CONSUMER PRICE INDEX ▪ Consumer price index (CPI) is the overall measure of the cost of the goods and services bought by a typical consumer. Copyright © 2020 by N...

MEASURING THE COST OF LIVING Chapter 6 Copyright © 2020 by Nelson Education Ltd. 6-1  THE CONSUMER PRICE INDEX ▪ Consumer price index (CPI) is the overall measure of the cost of the goods and services bought by a typical consumer. Copyright © 2020 by Nelson Education Ltd. 6-2  THE CONSUMER PRICE INDEX HOW THE CONSUMER PRICE INDEX IS CALCULATED ▪ Every month, Statistics Canada computes and reports the CPI. ▪ It uses data on the prices of more than 600 different goods and services. ▪ To see how these statistics are constructed, a simple economy with two goods is used: hot dogs and hamburgers. Copyright © 2020 by Nelson Education Ltd. 6-3  THE CONSUMER PRICE INDEX FIVE STEPS TO COMPUTING THE CPI AND THE INFLATION RATE 1. Determine the basket. Which prices are most important to the typical consumer. 2. Find the prices. Of each of the goods and services in the basket for each point in time. 3. Compute the basket’s cost. At different times. Copyright © 2020 by Nelson Education Ltd. 6-4  THE CONSUMER PRICE INDEX FIVE STEPS TO COMPUTING THE CPI AND THE INFLATION RATE (CONT’D) 4. Choose a base year and compute the index. 5. Compute the inflation rate. Copyright © 2020 by Nelson Education Ltd. 6-5  THE CONSUMER PRICE INDEX ▪ Statistics Canada calculates several other price indexes. ▪ For each province and territory and for 19 cities across Canada. ▪ For some narrow categories of goods and services (such as food, clothing, and shelter). ▪ “Core” inflation: a measure of the underlying trend in inflation. Copyright © 2020 by Nelson Education Ltd. 6-6 TABLE 6.1 Calculating the Consumer Price Index and the Inflation Rate: An Example Copyright © 2020 by Nelson Education Ltd. 6-7  What Is in the CPI’s Basket? FYI Copyright © 2020 by Nelson Education Ltd. 6-8  THE CONSUMER PRICE INDEX PROBLEMS IN MEASURING THE COST OF LIVING ▪ The CPI is not a perfect measure of the cost of living. 1. Commodity substitution bias 2. Introduction of new goods 3. Unmeasured quality change ▪ Taken together, these sources of bias cause the CPI to overstate the cost of living by 0.5 percentage points per year according to the Bank of Canada. Copyright © 2020 by Nelson Education Ltd. 6-9  THE CONSUMER PRICE INDEX THE GDP DEFLATOR VERSUS THE CONSUMER PRICE INDEX ▪ Economists and policymakers monitor both the GDP deflator and the CPI to gauge how quickly prices are rising. ▪ Usually, these two statistics tell a similar story. ▪ Two important differences can cause them to diverge: ▪ The GDP deflator reflects prices of goods and services produced domestically. ▪ The GDP deflator compares the price of currently produced goods and services with the price of the same goods and services produced during the base year. Copyright © 2020 by Nelson Education Ltd. 6-10 FIGURE 6.2 Two Measures of Inflation Copyright © 2020 by Nelson Education Ltd. 6-11  CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION ▪ The purpose of measuring the overall level of prices in the economy is to permit comparison between dollar figures from different points in time. Copyright © 2020 by Nelson Education Ltd. 6-12  CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION DOLLAR FIGURES FROM DIFFERENT TIMES ▪ Was the 1957 price of 9.5 cents per litre high or low compared with the 2018 price of gas ($1.30 per litre)? ▪ To compare the 1957 price of gas with the 2018 price, we need to inflate the price of 9.5 cents per litre to turn 1957 dollars into 2018 dollars. Copyright © 2020 by Nelson Education Ltd. 6-13  The Bank of Canada’s Inflation Calculator FYI https://www.bankofcanada.ca/r ates/related/inflation-calculator/ A basket of goods and services that cost $100 in 1914 would cost how much in 1973? In 1983? In 1993? In 2003? In 2018? Copyright © 2020 by Nelson Education Ltd. 6-14  case study Mr. Index Goes to Hollywood ▪ MCQ: What is the most popular movie of all time? A. Avatar What is the most popular movie of all time? B. Titanic C. Star Wars D. Gone with the Wind Copyright © 2020 by Nelson Education Ltd. 6-15  CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION INDEXATION ▪ Indexation: the automatic correction of a dollar amount for the effects of inflation by law or contract. ▪ COLA (cost-of-living allowance) automatically raises the wage when the CPI raises. Copyright © 2020 by Nelson Education Ltd. 6-16  CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION REAL AND NOMINAL INTEREST RATES ▪ Interest rates involve comparing amounts of money at different points in time. ▪ To fully understand interest rates, knowing how to correct for the effects of inflation is important. ▪ Suppose you make a deposit of $1000 in a bank account that pays interest at a rate of 10 percent per year. ▪ After one year, that bank account now contains $1100 (= principal of $1000 + interest of $100). ▪ Are you actually wealthier after one year? Copyright © 2020 by Nelson Education Ltd. 6-17  CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION REAL AND NOMINAL INTEREST RATES (CONT’D) ▪ Nominal interest rate: the interest rate that is usually reported without a correction for the effects of inflation. ▪ Real interest rate: the interest rate that is corrected for the effects of inflation. Copyright © 2020 by Nelson Education Ltd. 6-18  case study Interest Rates in the Canadian Economy What is the most popular movie of all time? Copyright © 2020 by Nelson Education Ltd. 6-19 THE END Copyright © 2020 by Nelson Education Ltd. 6-20