CPI & Market Basket
What does CPI stand for?
Consumer Price Index
A sustained increase in the overall price level
What is inflation?
What does "nominal" mean when discussing income or interest rates?
The value measured in the dollars of that time period, without adjusting for inflation.
The problem that occurs because consumers may change what they buy when relative prices change.
What is substitution bias?
A market basket costs $500 in the base year and $600 today. What is the price index?
$600 ÷ $500 × 100 = 120
A collection of goods and services typically purchased by consumers
What is a market basket?
When prices increase, what generally happens to purchasing power?
Purchasing power decreases
What does "real" mean?
A value adjusted for inflation.
If beef becomes much more expensive and consumers buy more chicken instead, what is this an example of?
Substitution
The CPI was 100 last year and 105 this year. What is the inflation rate?
(105 − 100) ÷ 100 × 100 = 5%
The year used as the comparison point for calculating a price index
What is the base year?
If the CPI increases from 100 to 110, what is the inflation rate?
10%
A bank pays you 7% interest and inflation is 3%. What is the approximate real interest rate?
4%
Why can new products create a problem when calculating the CPI?
New products may not immediately be included in the market basket.
The CPI was 150 last year and 162 this year. What is the inflation rate?
(162 − 150) ÷ 150 × 100 = 8%
If the CPI is 125, what does that tell us compared with the base year?
Prices are approximately 25% higher than in the base year.
The CPI was 120 last year and 126 this year. What is the inflation rate?
5%
You receive a 6% raise, but inflation is 8%. Did your real income increase or decrease?
Decrease
Why can changes in product quality make measuring inflation difficult?
A higher price may reflect an improved product rather than simply an increase in the price level
You have a nominal interest rate of 9% and inflation is 4%. What is the approximate real interest rate?
9% − 4% = 5%
Why are some items in the CPI market basket given more weight than others?
Because consumers spend more money on some goods and services than others.
If inflation is 8% and your income increases by only 5%, what happens to your real purchasing power?
It decreases because prices increased faster than income.
Why is real income more useful than nominal income when comparing purchasing power across different years?
Because real income adjusts for changes in prices/inflation
Name three problems associated with measuring the CPI.
Substitution bias, introduction of new products, and changes in product quality.
A market basket costs $1,200 in the base year and $1,500 today. What is the price index?
$1,500 ÷ $1,200 × 100 = 125