Download CPI - Southeast Missouri State University

Consumer Price Index
Chapter 7
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
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
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.
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)

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.
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.
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