Measuring the cost of living

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Measuring the cost of living

• Three common measures of the price level
• 1. GDP deflatordiscussed briefly last class
• 2. Consumer Price Index CPI
• 3. Producer Price Index PPI

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Consumer Price Index

• Most commonly used measure when we want to keep
  track of the cost of living.
• Originated by the government to determine
  appropriate wages for dock workers

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Example of consumer basket

• 2 movie tickets
• 4 lbs. chicken
• 6 McDonalds hamburgers
• 2 haircuts
• 1 trip to the doctor
• The CPI keeps track of the cost of this basket
  over time.

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What goods and services does the CPI cover?

• FOOD AND BEVERAGES (breakfast cereal, milk,
  coffee, chicken, wine, full service meals and
  snacks) 16
• HOUSING (rent of primary residence, owners'
  equivalent rent, fuel oil, bedroom furniture)
  41
• APPAREL (men's shirts and sweaters, women's
  dresses, jewelry) 4
• TRANSPORTATION (new vehicles, airline fares,
  gasoline, motor vehicle insurance) 17
• MEDICAL CARE (prescription drugs and medical
  supplies, physicians' services, eyeglasses and
  eye care, hospital services) 6
• RECREATION (televisions, cable television, pets
  and pet products, sports equipment, admissions)
  6
• EDUCATION AND COMMUNICATION (college tuition,
  postage, telephone services, computer software
  and accessories) 6
• OTHER GOODS AND SERVICES (tobacco and smoking
  products, haircuts and other personal services,
  funeral expenses 4

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Expenditure Survey

• About 30,000 individuals and families provide
  expenditure information for use in determining
  the importance, or weight, of over 2000
  categories in the CPI index structure.

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Simpler Example
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To convert into a price index

• To convert the market basket price series into an
  index number series
• 1. Pick a base year
• 2. Divide the series by the base year figure
• 3. Multiply by 100

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Inflation

• Compute the inflation rate by calculating the
  percentage change in the price index.

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Calculating the inflation rate
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• Inflation--when the price index increases
• Deflation--when the price index falls
• Currently we are experiencing inflation of about
  2.5

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Alternative measures of prices

• producer price index what producers pay for the
  goods and services they purchase to produce final
  goods and services
• Thought to provide us with forecasts of future
  inflation/deflation

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GDP deflator

• An alternative measure of inflation. Derived
  from NGDP and RGDP

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Important uses of the price index

• 2) to calculate the real interest rate--the true
  cost of borrowing.
• inominal ireal inflation rate
• Hence
• ireal inominal - inflation rate

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Important uses of the CPI

• 3) compare figures from different times

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Comparing figures over time

• Convert 1983 prices into 2004 prices

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Prices in December1983

• Bread per pound, white 0.55
• Chicken per pound, fresh, whole 0.81
• Oranges, Navel, per lb. 0.37
• Coffee, 100, ground roast, all sizes, per lb.
  2.44