cpi and other indices.pdf
TRANSCRIPT
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Measuring the Cost of
Living
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Measuring the Cost of Living Inflation refers to a situation in which the
economys overall price level is rising.
The inflation rate is the percentage changein the price level from the previous period.
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The Consumer Price Index The consumer price index(CPI) is a
measure of the overall cost of the goods
and services bought by a typical consumer. It is used to monitor changes in the cost of
living over time.
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WHAT CPI MEASURES? It measures Price changes of fixed market
basket of goods and services of constantquality and quantity.
It tells how much cost of living has risen or
fallen due to price changes irrespective ofchanges in consumer behaviour or qualityof goods.
It does not reflect the cost of living or in
house hold consumption expenditure assuch but only the influence of pricefluctuation on the trend.
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The Consumer Price IndexWhen the CPI rises, the typical
family has to spend more dollars to
maintain the same standard of
living.
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Consumer Price Index
Consumer Price Index is the main measure
of price changes at the retail level. It measures
changes in the cost of buying a representative
fixed basket of goods and services and isgenerally accepted as a measure of inflation in
the country.
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How the Consumer Price Index Is
Calculated Fix the Basket: Determine what prices
are most important to the typical
consumer.The Bureau of Labor Statistics (BLS)
identifies a market basket of goods and
services the typical consumer buys.
The BLS conducts monthly consumer
surveys to set the weights for the prices of
those goods and services.
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How the Consumer Price Index Is
Calculated
Find the Prices: Find the prices of each ofthe goods and services in the basket for
each point in time.
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How the Consumer Price Index Is
Calculated
Compute the Baskets Cost: Use the dataon prices to calculate the cost of the
basket of goods and services at different
times.
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How the Consumer Price Index Is
Calculated Choose a Base Year and Compute the
Index:
Designate one year as the base year, making it
the benchmark against which other years are
compared.
Compute the index by dividing the price of thebasket in one year by the price in the base year
and multiplying by 100.
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How the Consumer Price Index Is
Calculated
Compute the inflation rate: The inflationrate is the percentage change in the price
index from the preceding period.
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The Inflation Rate
The inflation rateis calculated as follows:
1001YearinCPI
1YearinCPI-2YearinCPIYear2inRateInflation
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Calculating the Consumer Price Index and the
Inflation Rate: An Example
Step 1:Survey Consumers to Determine a Fixed
Basket of Goods
4 hot dogs, 2 hamburgers
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Calculating the Consumer Price Index and the Inflation
Rate: An Example
Year
Price of
Hot dogs
Price of
Hamburgers
2001 $1 $2
2002 $2 $3
2003 $3 $4
Step 2: Find the Price of Each Good in Each Year
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Calculating the Consumer Price Index and the
Inflation Rate: An Example
2001 ($1 per hot dog x 4 hot dogs) + ($2 per hamburger x 2 hamburgers) = $8
2002 ($2 per hot dog x 4 hot dogs) + ($3 per hamburger x 2 hamburgers) = $14
2003 ($3 per hot dog x 4 hot dogs) + ($4 per hamburger x 2 hamburgers) = $20
Step 3: Compute the Cost of the Basket of Goods in
Each Year
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Calculating the Consumer Price Index and the Inflation
Rate: An ExampleStep 4: Choose One Year as the Base Year (2001) and
Compute the Consumer Price Index in Each Year
2001 ($8/$8) x 100 =1002002 ($14/$8) x 100 =175
2003 ($20/$8) x 100 = 250
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Calculating the Consumer Price Index and the Inflation
Rate: An Example
2002 (175-100)/100 x 100 = 75%
2003 (250-175)175 x 100 = 43%
Step 5: Use the Consumer Price Index to Compute the
Inflation Rate from Previous Year
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Calculating the Consumer Price Index and the Inflation
Rate: Another Example Base Year is 1998.
Basket of goods in 1998 costs $1,200.
The same basket in 2000 costs $1,236.
CPI = ($1,236/$1,200) X 100 = 103.
Prices increased 3 percent between 1998
and 2000.
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GDP DeflatorThe GDP deflator is calculated as follows:
100GDPReal
GDPNominal=deflatorGDP
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Housing
Food/Beverages
Transportation
Medical Care
Apparel
Recreation
Other
Education andcommunication
Whats in the CPIs Basket?
40%
16%
17%
6%
5%6%
5% 5%
h f
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Weights for CPI
The results of Family Budget Survey provide the average
percentage expenditure(Consumption pattern) of Households oneach item/each commodity group and for each income group for
the cities covered in CPI. These average percentage expenditures
on item and commodity groups are called weights and are being
used in computation of the CPI.Po x qo
Wi = ------------- x 100
Po x qo
Example: 1. Total Expenditure: Rs. 3000,
2. Expenditure on Wheat Flour:- Rs. 100
3. % of Expenditure on Wheat flour = (100/3000)*100 = 3.33
Weight of Wheat flour = 3.33%
F E l C di G Wi I d
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For Example: Commodity Groups Wise Items and
Weights C.P.I (2000-01)
Commodity Group Weights Items
01. Food, Beverages & Tobacco 40.34 124
02. Apparel, Textile & Footwear 6.10 42
03. House Rent 23.43 01
04. Fuel & Lightening 7.29 15
05. House Hold, Furniture & Equipment etc. 3.29 44
06. Transport & Communication 7.32 42
07. Recreation & Entertainment 0.83 16
08. Education 3.45 24
09. Cleaning, Laundry & Personal Appearance 5.88 26
10. Medicines/Medicare 2.07 29
TOTAL 100.00 374
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FORMULA USED FOR COMPUTATION OF CPI
Laspeyre's formula as given below is being used forthe computation of CPI.
(Pn/Po) x wi
In = --------------------- x 100
wiWhere In = CPI for the nth period
Pn = price of an item in the in the nth period
Po = price of an item in the base period
wi = weight of the ith item in the base period =Po x qo / Po x Qo
wi = Total weight of all items.
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EXAMPLE FOR COMPUTATION OF CPI
ITEM UNITBASEPRICE(Po)
PRICE INMAR, 06(Pn)
WEIGHT(Wi)
Pn/ PoPo/ Pn
x Wi
Moong Pulse Kg 29.91 47.61 0.2230 1.5918 0.3550
Mash Pulse Kg 45.01 52.72 0.2017 1.1713 0.2363
Masoor Pulse Kg 36.23 44.03 0.2214 1.2153 0.2691
Gram Pulse Kg 28.99 31.50 0.4272 1.0866 0.4642
1.0733 1.3246
(Pn/Po) x WiIndex = -------------------------------- x 100
Wi
1.3246I = -------------------------- x 100 = 123.41
1.0733
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Other Price Indexes The BLS calculates other prices
indexes:
The index for different regions within thecountry.
The producer price index, which
measures the cost of a basket of goodsand services bought by firms rather than
consumers.
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SENSITIVE PRICE INDICATOR (SPI)
Sensitive Price Indicator (SPI) is designed to
assess price movement of essential consumer
items at short intervals (on weekly basis ).
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WHOLE SALE PRICE INDEX (WPI)
Wholesale price index ( WPI) isdesigned to measure the change ofprice in the primary and wholesale
markets.
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WEIGHTS FOR WPI
The value of marketable surplus is being used forderiving weights of commodities/items included inWPI. The value of marketable surplus is the value ofcommodity available for sale in wholesale market. It
is equal to the total value of production lessconsumption by the producers less exports (if any)plus imports.
Example:- Production Self Consumption +Imports- Exports
Wheat = (100 )-(20) + (10) (10) =80
Value of Marketing Surplus= 80 x 1000 = 80000
Total Value of all the Items included in WPI =100,0000
% of Wheat in Total Value = (80000/1000000) x 100 = 8%
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Why Three Types of Indices?
CPImeasures Inflation rate in the country
SPIis computed to assess the price movement
of essential commodities at short interval oftime to review the price situation in the
country.
WPImeasures the General Price level in thewhole sale market.
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Limitation of CPI
1) Coverage is limited2) Only covers Urban Centres
3) Prices may have different trend in rural &
urban centres.4) Rent is computed through construction
input items index instead of rent survey.
5) It measures partially inflation not totalconsumers expenditure.
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Problems in Measuring The Cost of
LivingThe CPI is an accurate measure of the
selected goods that make up the typical
bundle, but it is not a perfect measure of
the cost of living.
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Problems in Measuring The Cost of
Living Substitution bias
Introduction of new goods Unmeasured quality changes
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Substitution Bias The basket does not change to reflect
consumer reaction to changes in relative
prices.Consumers substitute toward goods that have
become relatively less expensive.
The index overstates the increase in cost ofliving by not considering consumer
substitution.
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Introduction of New Goods The basket does not reflect the change in
purchasing power brought on by the
introduction of new products.New products result in greater variety, which in
turn makes each dollar more valuable.
Consumers need fewer dollars to maintain anygiven standard of living.
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Unmeasured Quality Changes If the quality of a good rises from one year
to the next, the value of a dollar rises, even
if the price of the good stays the same. If the quality of a good falls from one year
to the next, the value of a dollar falls, even
if the price of the good stays the same.
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Unmeasured Quality ChangesThe BLS tries to adjust the price forconstant quality, but such
differences are hard to measure.
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Problems in Measuring the Cost of Living The substitution bias, introduction of new
goods, and unmeasured quality changes cause
the CPI to overstate the true cost of living.The issue is important because many government
programs use the CPI to adjust for changes in the
overall level of prices.
The CPI overstates inflation by about 1 percentage
point per year.
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The GDP Deflator versus the Consumer
Price Index
Economists and policymakers monitor
both the GDP deflator and the consumer
price index to gauge how quickly prices
are rising.
There are two important differences
between the indexes that can causethem to diverge.
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The GDP Deflator versus the Consumer
Price Index The GDP deflator reflects the prices of all
goods and services produced
domestically, whereas...
the consumer price index reflects the
prices of all goods and services bought
by consumers.
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The GDP Deflator versus the Consumer
Price Index The consumer price index compares the price of a
fixed basketof goods and services to the price of
the basket in the base year (only occasionally doesthe BLS change the basket)...
whereas the GDP deflator compares the price of
currently producedgoods and services to the price
of the same goods and services in the base year.
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1965
Percent
per Year15
10
5
01970 1975 1980 1985 1990 1995 2000
CPI
Two Measures of Inflation
GDP deflator
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Dollar Figures
from Different TimesPrice indexes are used to correct
for the effects of inflation when
comparing dollar figures from
different times.
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Dollar Figures
from Different Times Do the following to convert (inflate) Babe
Ruths wages in 1931 to dollars in 1995:
1931inlevelPrice
1999inlevelPriceSalary=Salary 19311999
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Dollar Figures from Different Times Do the following to convert (inflate) Babe
Ruths wages in 1931 to dollars in 1995:
$873,684=
15.2
166$80,000=
1931inlevelPrice
1999inlevelPriceSalary=Salary 19311999
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The Most Popular Movies of All Time, Inflation
AdjustedFilm
Year ofRelease
Total domestic grossin millions of 1999 dollars
1. Gone with the Wind 1939 $920
2. Star Wars 1977 798
3. The Sound of Music 1965 638
4. Titanic 1997 601
5. E.T.The Extra Terrestrial 1982 601
6. The Ten Commandments 1956 587
7. Jaws 1975 574
8. Doctor Zhivago 1965 543
9. The Jungle Book 1967 485
10. Snow White and the Seven Dwarfs 1937 476
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IndexationWhen some dollar amount is
automatically corrected for inflation bylaw or contract the amount is said to
be indexed for inflation.
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Real and Nominal Interest RatesInterest represents a payment inthe future for a transfer of
money in the past.
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Real and Nominal Interest Rates The nominal interest rate is the interest
rate not corrected for inflation.
It is the interest rate that a bank pays. The real interest rate is the nominal interest
rate that is corrected for inflation.
Real interest rate = (Nominal interest rate Inflation rate)
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Real and Nominal Interest Rates You borrowed $1,000 for one year.
Nominal interest rate was 15%.
During the year inflation was 10%.
Real interest rate = Nominal interest rate Inflation
=15% - 10% = 5%
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1965
Interest Rates(percent per
year)
15
10
5
0
-51970 1975 1980 1985 1990 1995 1998
Nominalinterest rate
Real interest rate
Real and Nominal Interest Rates
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Summary The consumer price index shows the cost of
a basket of goods and services relative to the
cost of the same basket in the base year.
The index is used to measure the overalllevel of prices in the economy.
The percentage change in the CPI measures
the inflation rate.
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Summary The consumer price index is an imperfect
measure of the cost of living for the
following three reasons: substitution bias,
the introduction of new goods, andunmeasured changes in quality.
Because of measurement problems, the CPI
overstates annual inflation by about 1percentage point.
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Summary The GDP deflator differs from the CPI
because it includes goods and services
produced rather than goods and services
consumed.
In addition, the CPI uses a fixed basket of
goods, while the GDP deflator
automatically changes the group of goodsand services over time as the composition
of GDP changes.
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Summary Dollar figures from different points in
time do not represent a valid comparison
of purchasing power.
Various laws and private contracts useprice indexes to correct for the effects of
inflation.
The real interest rate equals the nominalinterest rate minus the rate of inflation.
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Graphical
Review
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Whats in the CPIs Basket?Housing
Food/Beverages
Transportation
Medical Care
Apparel
Recreation
Other
Education andcommunication
40%
16%
17%
6%
5%6%
5% 5%
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Two Measures of Inflation
1965
Percent
per Year15
10
5
01970 1975 1980 1985 1990 1995 2000
CPI
GDP deflator
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1965
Interest Rates(percent per
year)
15
10
5
0
-51970 1975 1980 1985 1990 1995 1998
Nominalinterest rate
Real interest rate
Real and Nominal Interest Rates