Consumer Price Index

1
Consumer Price Index

• Chapter 7

2
Price Index

• Price index is the average level of prices in the
  economy and inflation is measured by the rate of
  changes in this index.
• Three types of price index
• Consumer price index (CPI)
• Producer price index (PPI)
• GDP deflator the most comprehensive price index

3
CPI (Consumer Price Index)

• A measure of the average of the prices paid by
  urban consumers for a fixed maker basket of goods
  and services
• CPI basket 80,000 products in the eight broad
  categories
• Monthly price survey by BLS employees
• CPI calculation
• Cost of current year CPI basket / cost of base
  year CPI basket 100

4
Inflation Rate

• Inflation rate is the percentage change in a
  price index (CPI).
• Inflation rate reflects changes in the cost of
  living.
• Formula
• Inflation rate change in CPI / previous (or
  base) CPI 100
• Higher inflation rates during the 1970s and 1980s
  and lower inflation rates during the 1990s.

5
Related Terms to Inflation

• Deflation the price index declines (the
  inflation rate is negative)
• Disinflation the rate of inflation declines (the
  price index still rises)
• Hyperinflation the extremely high rate of
  inflation (annually 100 or more)

6
Bias in CPI

• The CPI is sometimes called a cost of living
  index, but not true for two reasons
• It does not measure price changes of all products
  (only 80,000)
• It does not always measure accurately due to the
  bias.
• Sources of bias new products, quality changes,
  commodity substitution, outlet substitution
• The bias in the CPI results in overstatement of
  the inflation rate by 1.1.
• Also resulting in increased government outlays
  and distorted wage contracts.

7
Bias in GDP Deflator

• GDP deflator also suffers from the bias, but to a
  lesser degree due to the facts that
• It includes new products and quality improvement
  and allows substitution to some extent.
• It covers a broader range of products
• The GDP deflator has increased slower than the
  CPI over the last 20 years.

8
Nominal vs. Real Values

• Nominal vs. real prices
• Real price nominal price / CPI 100
• Nominal vs. real wage rates
• Real wage rate nominal wage rate / CPI 100
• The nominal wage rate has increased rapidly, but
  the real wage rate has increased very mildly.
• Nominal vs. real interest rates
• Real interest rate nominal interest rate
  inflation rate