Measuring the Cost of Living

1
Measuring the Cost of Living

• Professor Chris Adam
• Australian Graduate School of Management
• University of Sydney and University of New South
  Wales

2
INTRODUCTION

• How to compare dollar-based data from one period
  to another?
• Use of index numbers
• Consumer Price Index
• GDP Deflator
• Real interest rates
• Real exchange rates

3
CONSUMER PRICE INDEX

• Measure of overall cost of goods and services
  bought by typical consumer
• Monthly measure based on basket of consumption
  goods and services
• Selection of basket content, appropriate prices,
  and base year
• Inflation rate calculation
• Producer Price Index

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INFLATION
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PROBLEMS IN COL MEASUREMENT

• Substitution bias
• If price changes not uniform, consumers may alter
  consumption basket contents
• chaining CPI measures to allow for changing
  baskets
• Introduction of new goods
• New goods offer more variety, to enhance value of
  dollars spent and reduce cost of standard of
  living

6
PROBLEMS IN COL MEASUREMENT

• Unmeasured quality change
• Deterioration of quality reduces value of dollar
  spent on good
• Adjustment to prices to allow for change of
  quality
• Asset price inflation versus gs (flow) inflation

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EXPECTATIONS OF INFLATION
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GDP DEFLATOR vs CPI

• GDP deflator measures domestic production but CPI
  includes foreign gs
• GDP basket is actual production but CPI is fixed
  basket

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AUSTRALIAN GDP DEFLATOR vs CPI
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USES OF INFLATION CORRECTION

• Dollar figures from different times
• Indexation
• Basic wage claims
• Pension benefits
• Public utility prices
• Bond values
• Real and nominal interest rates
• Real and nominal exchange rates

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INTERNATIONAL PRICE INDICES