Download Chapter 24: Measuring the Cost of Living

Warm Up
 How are real & nominal GDP
different?
 What equation connects them?
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It sure adds
up quickly!
Chapter 24: Measuring
the Cost of Living
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Overview
 CPI
 COLAS
 Real vs nominal interest rates
 Vocab is the same list
 15 slides
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Backwards first
 Last chapter we introduced GDP
 Real vs nominal
 GNP, NDP, PI, NI, DI, NEW
 Income & expenditure approach
 It’s great to know the total, but
what does it cost us?
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Rising Sun
 Prices increasing is almost as
consistent as the sun
 Some more than others
 Sometimes it’s DEFLATION
 DISINFLATION & HYPERINFLATION
 Also galloping & moderate
 Bottom line is that prices increase
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Making sense of cents
 It’s a mess to keep straight
 Most rise, a few fall
 What’s it mean overall?
 Analyze everything together
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CPI




Take a big “market basket”
Add up the cost
Do it every month forever
Use tallies to evaluate inflation
 Tells us overall how much prices are
changing for the average consumer
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3 step Process




1.
2.
3.
4.
Set the “MARKET BASKET”
Find the prices
Compute cost for basket
Set a base year
 Analyze inflation over that period
 5. Calculate CPI
 Equation?
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Others care too
 It’s not the only one…
 It is the most commonly used
 PPI
 Whole purpose is to track prices
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Wha’t it used for?
 It’s great to know
 Serve a real purpose?
 Who uses it?
 Best tool gov’t has for checking
burden on “average” consumer
 Often times COLA based on it
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Now & Later
 Inflation affects your money now
 Also reduces value later
 $5 used to buy a lot
 $.49 cheeseburgers at McDees
 $.39 tacos on Sunday
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Banks aren’t losers
 Banks must consider this
 Money loaned out is worth less
when repaid
 Add expected inflation onto price
charged for loan (interest rate)
 The rate you pay now (nominal)
= expected inflation +real IR
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Can’t expect the unexpected
 Banks consider “EXPECTED
INFLATION”
 What if it’s not expected?
 Who suffers?
 Who benefits?
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Use in moderation
 So far it sounds like inflation is all
bad
 No really, but can be when not
controlled
 Moderate is ok (ideally 2-3%)
 When we have time to adjust it’s
all good (gas of late)
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Summary
 Prices go up…it’s inevitable
 Price indices used to estimate burden
to consumers
 CPI most popular (relevant)
 Directly affects interest rates (nominal
= real + inflation)
 HW:
 Questions for Review (p 532): 1, 4
 Problems & Aps (p 532): 2,
3, 5, 6, 11
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