Download Measuring Inflation

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GDP Recession?
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Price Index
A price index is a number that
represents overall prices for a
given period of time –say a year-.
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Garcia-Szekely
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Measuring Inflation:The
Consumer Price Index
Claudia Garcia-Szekely
(c) 2000,2001, 2002 Claudia Garcia - Szekely
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The CPI relevant to consumers
and workers
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Determines how much consumers pay for goods and services.
Principal source of information for trends in consumer prices
and inflation.
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Helps set labor contracts and government policy.
Influences quality of life for retirees.
Landlords use it to determine future increases in rents.
Judges use it to determine alimony and child support
payments.
Used to adjust payments to:
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It is one of the most important indicators of inflation. High
inflation equals high interest rates. Low inflation allows interest
rates to fall.
Social Security recipients (50 million)
Federal and Military retirees
Food Stamps and School Lunches (25 million)
Used to adjust individual income tax brackets.
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The Consumer Price Index
The CPI is a measure average change in
retail prices over time for a basket of
goods and services.
200 categories of goods
and services divided into
eight groups and weighted
by importance.
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Current Market Basket
•Weights determined by survey about actual purchases
in 2003 and 2004. Weights are revised every two years
to adjust for changing tastes and priorities.
•In each year, more than 5,000 families from around
the country provided information on their spending
habits in a series of quarterly interviews.
•To collect information on frequently purchased items
such as food and personal care products, another 5,000
families in each of the 3 years kept diaries listing
everything they bought during a 2-week period.
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Updating the Market Basket
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CPI revisions occur approximately
every 10 years.
The most important revision is the
introduction of a new “market
basket”
The last revision to the CPI started
in 1998 and completed in 2000.
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3 trips
The CPI
1. Fix the basket:
select the most
commonly
purchased items
by conducting
surveys.
1 computer
5 Doctor visits
2 tuitions
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The CPI
Ticket = $600
2. Find the prices of
the items included
in the basket:
scouts go every
month looking for
these prices.
Computer=$1200
Doctor Visit=$100
Tuition =$20,000
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Cost of the Basket Y2000
$43,500
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The CPI
Ticket Price in
1995 = $500
4. Choose a base year the benchmark for
comparison- and
compute the cost of
the basket in the
base year…Say 1995
Computer Price in
1995 =$1500
Tuition in 1995
=$20,000
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Doctor Visit in
1995 =$90
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Cost of the Basket in the Base
Year (1995)
Note: Same items,
same quantities,
same qualities we
used for 2000
$43,450
$1,500
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The CPI
5. Compute the CPI.
CPI (Year 2000) =
Cost of Basket in 2000 x100
Cost of Basket Base Year
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Calculating the CPI
1. Fix the quantities and items in the
basket.
2. Find the prices of these items.
3. Compute the cost of the items in
the basket at each year’s prices.
4. Choose a base year -the benchmark
for comparisonCost of Basket in 2000 x100
CPI (Year 2000) =
Cost of Basket Base Year
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Calculate Cost of basket in
each year…
Year Price X Quantity X Price Y Quantity YPx *4 Py*2 Basket
X
X
X
4
5
6
2X 2
X
3
3
4
5
X
2000 1
2001 2
2002 3
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4+4
8+6
12 + 8
=
8
= 14
= 20
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CPI = Basket cost Year X
/Basket cost base year.
Year
Cost of the
Basket
2000
8
2001
14
2002
20
CPI
(8/8)*100
= 100
(14/8)*100
= 175
(20/8)*100
= 250
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Inflation
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Measures the rate of CHANGE in prices.
Is calculated from a price index, for
different time periods: months, quarters,
years.
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The Inflation Rate for Year X
-
(Price Index previous year)
X 100
(Price Index previous year)
(Price Index Year X)
You need 75%
more money in
2001 than in
2000 to buy
the same goods
Calculating the Inflation Rate
Year
CPI
2000
100
Inflation rate
2001
175
75
2002
250
42.86
175 - 100
X100 = 75%
100
250 - 175
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175
X 100 = 43%
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What goods and services
does the CPI cover?
All goods and services purchased for
consumption are classified into 200
categories, arranged into eight major
groups.
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Garcia-Szekely
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The CPI includes
1.
2.
3.
4.
5.
6.
7.
8.
FOOD AND BEVERAGES (breakfast cereal, milk, coffee,
chicken, wine, full service meals and snacks);
HOUSING (rent of primary residence, owners' equivalent rent,
fuel oil, bedroom furniture);
APPAREL (men's shirts and sweaters, women's dresses,
jewelry);
TRANSPORTATION (new vehicles, airline fares, gasoline,
motor vehicle insurance);
MEDICAL CARE (prescription drugs and medical supplies,
physicians' services, eyeglasses and eye care, hospital
services);
RECREATION (televisions, cable television, pets and pet
products, sports equipment, admissions);
EDUCATION AND COMMUNICATION (college tuition,
postage, telephone services, computer software and
accessories);
OTHER GOODS AND SERVICES (tobacco and smoking
products, haircuts and other personal services, funeral
expenses).
Although not a “price” CPI includes…
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Also included are various government-charged
user fees:
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The CPI also includes taxes:
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such as sales and excise taxes that are directly
associated with the prices of specific goods and
services.
The CPI excludes taxes:
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water and sewerage charges, auto registration fees,
and vehicle tolls.
such as income and Social Security taxes that are not
directly associated with the purchase of consumer
goods and services.
The CPI does not include investment items:
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such as stocks, bonds, real estate, and life insurance.
Because these items relate to savings and not to dayto-day consumption expenses.
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The Core Consumer Price Index
Measures what consumers are paying for goods and
services at malls, grocery stores and other retail
locations.
Unlike the overall CPI, it excludes food and energy
prices, which can bounce around enough each month to
distort the overall price trend picture.
For the most recent core CPI data, click here.
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Relative Importance Dec 2006
What is included in each
category?
Problems Measuring the Cost
of Living
1. Substitution Bias: Because the
basket is fixed, the CPI does not
account for substitutions consumers
do in response to higher prices.
 Substitution away from “frozen
desserts” to “cake-like desserts”.
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Geometric Mean Estimator
•Employs a set of fixed expenditure
proportions
as weights.
3 apples
•Consumers
alter the quantities of goods
4 ice can
cream
and services
they buy within the category,
bars
when the relative prices of those goods and
3 fruits
services change.
4 frozen
desserts
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Problems with CPI…
2. New Goods Bias: Not included in the
basket. Consumers spend less to attain
the same (or higher) standard of living.
CPI does not reflect this change in the
purchasing power of a dollar.
3. Unmeasured Quality change: If quality
improves, the value of the dollar rises.
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Inflation
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Inflation refers to an INCREASE in
the price level from one period to
the next.
Inflation can be high (20%) or low
(2%)
When inflation drops from 20% to
2% prices still INCREASE, but not as
much as the previous time period.
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Deflation
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Deflation refers to a DECREASE in the
price level from one period to the next.
Deflation shows up as a NEGATIVE
number for the inflation rate: a –5%
“inflation” means that prices DECREASED
by 5%.
This is not only a slowing down of inflation
but a DROP in prices.
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Year
CPI
1970
For which 39.8
years
there is Deflation?
1971
41.1
Inflation?
1972
42.5
1973
46.3
1974
51.9
1975
55.6
1976
58.4
1977
62.3
1978
67.9
1979
76.9
1980
66.9
Inflation
3.3
3.4
8.9
12.1
7.1
5.0
6.7
9.0
13.3
-13.0
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The GDP Deflator
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The GDP deflator is a price index.
It is calculated from nominal and real
GDP.
Sometimes called “implicit” price
deflator because it is the price implicit
in the difference between real and
nominal.
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The GDP Deflator Formula
Nominal GDP
GDP Deflator =
X 100
Real GDP
Also called the GDP Price Index
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Year
CPI
2005
195.3
2006
201.6
2007
207.342
Calculate the inflation rate for these
three years.
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Inflation Rate for 1999
(Deflator Year X)
-
(Deflator previous year)
X 100
(Deflator previous year)
Year
2005
2006
2007
GDP Deflator Inflation Rate
113
116
119
Calculate the inflation rate for these
three years.
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The GDP Deflator vs. the CPI
1.
GDP Deflator reflects the prices of
all goods and services produced
domestically bought by consumers,
the government and other countries.
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The GDP Deflator vs. the CPI
1. The CPI reflects prices of goods
purchased by consumers only. The
CPI does not take into account
prices of goods and services bought
by the government or foreigners.
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The GDP Deflator vs. The
CPI
2. The CPI uses a fixed basket
whereas the GDP deflator uses
prices of currently produced goods.
5
1
2
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Comparing dollar values from
different years
$100 in 1930 is not the same as $100 in
2000.
Why not?
Because prices were different: $100 used to
buy you more then…
To compare $100 in 1931 with $100 today we
must find out what $100 used to buy in
1930 and compare that to what $100 buys
today..
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Moving dollar values forward
in time…
CPI (1930) = 16.7
CPI (2000) = 172.2
1930
$100
2000
(172.2)/(16.7)
Multiply by 10.31
=10.31
$1,031
?
Prices in 2000 are 10.31 times larger than in
1930
You need to have 10.31 times as much money in 2000
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Example
If you want to know what is the equivalent in
today’s dollars of an $80,000 salary in
1931,
1. Find the ratio of prices:
10.31
CPI in 2000 / CPI in 1931 = 172.2/16.7 = ___
824,910.2
2. Multiply 80,000 by that # =________
An $80,000 salary in 1931 is equivalent to a
824,910.2
$_________salary
in 2000.
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Using the Inflation Calculator
The Presidential salary from 1909-1949
was $75,000 annually (President Hoover
1929 - 1933) CPI = 17.1
 George W. Bush salary is $200,000
annually. CPI = 179.9
Do we pay our president a salary equivalent
to that of President Hoover?
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Inflation Calculator
This site finds the equivalencies
for dollars in different years.
http://data.bls.gov/cgibin/cpicalc.pl
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Garcia-Szekely
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Questions to prepare for the test
1. Is the CPI inflation rate
measured correctly? In your
answer you must mention the
new goods bias, the quality
bias and the substitution
bias. Provide an example for
each to illustrate your
answer.
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2. In 1964 earnings per hour were $7.96 (CPI=
31). Today, earnings per hour are
$45(CPI=196.4). Are per hour earnings today
equivalent to those in 1964? WHY or why
not?
3. In what way are the CPI and the GDP
deflator the same? In what way are they
different?
4. Use the data in the table in the next slide to
calculate:
a) Inflation rate 1975
b) Inflation rate 1980
5. Identify Inflation/Deflation.
Year
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
CPI
Inflation
39.8
41.1
42.5
46.3
51.9
55.6
58.4
62.3
67.9
76.9
66.9
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3.3
3.4
8.9
12.1
7.1
5.0
6.7
9.0
13.3
-13.0
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6. Which items are included in the CPI basket?
Breakfast cereal, milk, coffee, chicken, wine, full
service meals and snacks
Rent of primary residence, owners' equivalent
rent, fuel oil, bedroom furniture
Men's shirts and sweaters, women's dresses,
jewelry
New vehicles, airline fares, gasoline, motor
vehicle insurance
Income and Social Security taxes
Stocks, bonds, real estate, and life insurance
Sales taxes
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Employment Cost Index (ECI)
Average Hourly Earnings (AHE)
ECI comes out quarterly and measures changes in
employee wages, salaries and benefits.
AHE, the Employment Situation report, comes out
monthly, shows how worker wages are changing month
to month.
Both are important because rapidly rising labor costs
can force businesses to raise prices to compensate,
spurring inflation. For the most recent ECI data, click
here. For the most recent AHE data, click here
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More Information on the CPI
Go to:http://data.bls.gov/cgibin/surveymost?cu
Check on first box: U.S. All
items, 1982-84=100 CUUR0000SA0
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