Macro 23 notes

Macro 23 notes

The CPI and the cost of living

Economic Goals
Job and Unemployment <6%
CPI and Inflation <3%

What is Inflation?
What is deflation?
An increase in the general(average) price level of goods and services a typical American urban household buys each month.
A decrease in the general price level of goods and services a typical urban American household buys each month.

Consumer Price Index
1. A measure of the Average of the prices paid by urban consumers for a fixed market basket of consumer goods and services.
2. The BLS calculates the CPI every month.
3. www.bls.gov
4 Each month, BLS employees check the prices of the 80,000 goods and services in the CPI basket in 30 metropolitan areas.
5. Because the CPI measures price changes, it is important that the prices recorded refer to similar market basket of goods.
6. We can use these numbers to compare what a fixd basket of goods costs this month(current year) and what it costs some previous (base year)month.
7. CPI is the most widely reported measure of inflation.

Average prices of market basket of goods is calculated in 1989.
Average prices of market basket of similar goods is calculated in 2009.

The base year in this example is 1982-84.
The current year in this example is 2011.
The CPI is defined to equal 100 for a period called the reference base period(1984)
The CPI calculated for the current year, 2011, is 225.54.

COnstructing the CPI
Three stages:
Selecting the CPI basket
Conducting the monthly price survey

CPI= (Cost of CPI basket at current period prices)/(Cost of CPI basket at base period prices)x100

Measuring Iflation
Inflation rate
The percentage change in the price level from one year to the next.

Sources of Bias in teh CPI
-New Goods Bias
New goods do a better job than the old ones but cost more
The arrival of new goods puts an upward bias into the CPI and its measure of the inflation rate.
-Quality Change Bias
Better cars and televisions cost more
-Commodity substitution bias
Substituting one product for another because the one is less expensive(chicken over beef)
The CPI basket doesn't change to allow for the effects of substitution between goods.
-Outlet substitution bias
If prices rise more rapidly, people use discount stores more frequently
The CPI basket doesn't change to allow for the effects of outlet substitution.

Two Consequences of the CPI Bias
-Distortion of private agreements
-Increases in government outlays

Distortion of Private Agreements
-Many private agreements, such as wage contracts, are linked to the CPI.

Application of CPI
Retirement planning/pension plans
Standard of living
Purchasing power of your income
Inflation rate
Pay negotiation/private agreements
Union contracts
The CPI is used to adjust government obligations
49 million Social Security benefit Payments
27 million receiving food stamps
4 million pensions for retired military personnel, federal/civil servants, and their surviving spouses

The link between GDP, Unemployment, and Inflation
When real GDP decreased in the recession, the unemployment rate decreased.
A little later, the inflation rate decreased.
As real GDP increased back toward potential GDP, the unemployment rate fell toward the natural unemployment rate and the inflation rate increases.