Measuring the Cost of Living Principles of Macroeconomics PDF

PowerPoint Presentations for Principles of Macroeconomics Ninth Canadian Edition by Mankiw/Kneebone/McKenzie Adapted for the Ninth Canadian Edition by Marc Prud’Homme Universit...

PowerPoint Presentations for Principles of Macroeconomics Ninth Canadian Edition by Mankiw/Kneebone/McKenzie Adapted for the Ninth Canadian Edition by Marc Prud’Homme University of Ottawa Copyright © 2024 Cengage Learning Ltd. 6-1 MEASURING THE COST OF LIVING Chapter 6 Copyright © 2024 Cengage Learning Ltd. 6-2  MEASURING THE COST OF LIVING  This chapter examines how economists measure the overall cost of living.  The consumer price index is used to monitor changes in the cost of living over time.  When the consumer price index rises, the typical family has to spend more dollars to maintain the same standard of living.  Economists use the term inflation to describe a situation in which the economy’s overall price level is rising.  The inflation rate is the percentage change in the price 6 level from the previous period. Copyright © 2024 Cengage Learning Ltd. 5-3  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. 6-1 Copyright © 2024 Cengage Learning Ltd. 6-4  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 6- simple Copyright © 2024 Cengage Learning Ltd. 6-5 1a  THE CONSUMER PRICE INDEX FIVE STEPS TO COMPUTING THE CPI AND THE INFLATION RATE 1. Determine the basket to determine 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 6- 1a times. Copyright © 2024 Cengage Learning Ltd. 6-6  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. 6- Copyright © 2024 Cengage Learning Ltd. 6-7 1a  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. 6- Copyright © 2024 Cengage Learning Ltd. 6-8 1a  TABLE 6.1 Calculating the Consumer Price Index and the Inflation Rate: An Example 6- Copyright © 2024 Cengage Learning Ltd. 6-9 1a  FY What Is in the CPI’s Basket? I 6- Copyright © 2024 Cengage Learning Ltd. 6-10 1b  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 6- CPI to overstate the cost of living by 0.5 Copyright © 2024 Cengage Learning Ltd. 6-11 1b  FY 20 Years of Price Changes in Canada I 6- Copyright © 2024 Cengage Learning Ltd. 6-12 1b  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. 6-  The GDP deflator Copyright 1c compares theLearning © 2024 Cengage price Ltd.of currently produced 6-13  FIGURE 6.3 Two Measures of Inflation 6- Copyright © 2024 Cengage Learning Ltd. 6-14 1b  Active Learning Calculate the CPI CPI basket: {10 kg beef, 20 kg price of price of chicken} beef chicken The CPI basket cost $120 in 2021, the 2021 $4 $4 A. Compute base year. the CPI in 2022. 2022 $5 $5 B. What was the CPI inflation rate from 2022 to 2023? 2023 $9 $6 6-1 Copyright © 2024 Cengage Learning Ltd. 6-15  Active Learning Calculate the CPI - Answers A. Compute the CPI in 2022. Cost of CPI basket in 2022 = ($5 × 10) + ($5 × 20) = $150 CPI in 2022 = 100 × ($150/$120) = 125 6-1 Copyright © 2024 Cengage Learning Ltd. 6-16  Active Learning Calculate the CPI - Answers B. What was the CPI inflation rate from 2022 to 2023?of CPI basket in 2023 Cost = ($9 × 10) + ($6 × 20) = $210 CPI in 2023 = 100 × ($210/$120) = 175 CPI inflation rate 2023 / 2022 = (175 – 125)/125 = 40% 6-1 Copyright © 2024 Cengage Learning Ltd. 6-17  An Overview of Canada’s Consumer Price Index (CPI) https://www.youtube.com/watch?v=qfKmJe3CK6E The Consumer Price Index and Your Experience of Price Change https://www.youtube.com/watch?v=U0xDcqE-zNs 6-1 Copyright © 2024 Cengage Learning Ltd. 6-16  Quick Quiz 1. The CPI measures 4. Because consumers can approximately the same sometimes substitute economic phenomenon as cheaper goods for those that have risen in price, a. nominal GDP. a. the CPI overstates b. real GDP. inflation. c. the GDP deflator. b. the CPI understates inflation. d. the unemployment rate. c. the GDP deflator overstates inflation. d. the GDP deflator understates inflation. 6-1 Copyright © 2024 Cengage Learning Ltd. 6-19 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. 6-2 Copyright © 2024 Cengage Learning Ltd. 6-20 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 2021 price of gas ($1.30 per litre)?  To compare the 1957 price of gas with the 2021 price, we need to inflate the price of 9.5 cents per litre to turn 1957 dollars into 2021 dollars. 6- Copyright © 2024 Cengage Learning Ltd. 6-21 2a 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 6- Copyright © 2024 Cengage Learning Ltd. 6-22 2b 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). 6- 2c  Are you actually wealthier after one year? Copyright © 2024 Cengage Learning Ltd. 6-23 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 6- Copyright © 2024 Cengage Learning Ltd. 6-24 2c  case Interest Rates in the Canadian stud Economy y What is the most popular movie of all time? 6- Copyright © 2024 Cengage Learning Ltd. 6-25 2c  Quick Quiz 5. If the CPI is 200 for the 6. You deposit $2000 in a year 1980 and 300 today, savings account, and a year then $600 in 1980 has the later you have $2100. same purchasing power as Meanwhile, the CPI rises ___ has today. from 200 to 204. In this case, the nominal interest a. $400 rate is ___ percent, and the real interest rate is ___ b. $500 percent. c. $700 a. 1; 5 d. $900 b. 3; 5 c. 5; 1 d. 5; 2 6-2 Copyright © 2024 Cengage Learning Ltd. 6-26 THE END Copyright © 2024 Cengage Learning Ltd. 6-27