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Measuring Inflation:The Consumer Price Index

Claudia Garcia-Szekely. Measuring Inflation:The Consumer Price Index. Inflation. Measures the rate of CHANGE in prices. Is calculated from a price index , for different time periods: months, quarters, years. Price Index.

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Measuring Inflation:The Consumer Price Index

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  1. Claudia Garcia-Szekely Measuring Inflation:The Consumer Price Index (c) 2000,2001, 2002 Claudia Garcia - Szekely

  2. Inflation • Measures the rate of CHANGE in prices. • Is calculated from a price index, for different time periods: months, quarters, years. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  3. Price Index A price index is a number that represents overall prices for a given period of time –say a year-. (c) 2000,2001, 2002 Claudia Garcia - Szekely©2001Claudia Garcia-Szekely

  4. The Consumer Price Index The CPI was developed during World War I to meet the need of the Federal Government for establishing cost-of-living adjustments for workers in shipbuilding centers. (c) 2000,2001, 2002 Claudia Garcia - Szekely©2001Claudia Garcia-Szekely

  5. The Consumer Price Index • Principal source of information for trends in consumer prices and inflation. • Used for escalation of contract amounts and payments among individuals and organizations. • Used to adjust payments to: • Social Security recipients • Federal and Military retirees • Food Stamps and School Lunches • Used to adjust individual income tax brackets. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  6. CPI The Consumer Price Index The CPI is a measure of prices for a fixed basket of goods and services of constant quantity and quality purchased by consumers. Measures the overall cost of the goods and services bought by a typical consumer. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  7. Calculating the CPI • The CPI uses a “representative basket” includes goods and services bought by a typical consumer. • Scouts are sent every month to find out the prices of all the items in the basket. We will use a simplified four-good example (c) 2000,2001, 2002 Claudia Garcia - Szekely

  8. The CPI 3 trips • Fix the basket: select the most commonly purchased items by conducting surveys. 1 computer 5 Doctor visits 2 tuitions (c) 2000,2001, 2002 Claudia Garcia - Szekely

  9. Current Market Basket • For the current CPI, information was collected from the Consumer Expenditure Survey over the three years 1993, 1994, and 1995. • 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. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  10. The CPI Ticket = $600 • 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 (c) 2000,2001, 2002 Claudia Garcia - Szekely

  11. 3 Tickets = $1800 1 Computer= $1200 5 Doctor Visits= $500 2Tuitions = $40,000 The CPI • Compute the costof the items in the basket each year. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  12. Cost of the Basket Y2000 2 Tuitions $20,000/ea 1 Computer $1,200/ea 5 Doctor visits $100/ea 3 tickets $600/ea $500 $43,500 $1,800 $40,000 $1,200 (c) 2000,2001, 2002 Claudia Garcia - Szekely

  13. Ticket Price in 1995 = $500 Computer Price in 1995 =$1500 Doctor Visit in 1995 =$90 Tuition in 1995 =$20,000 The CPI • Choose a base year -the benchmark for comparison- and compute the cost of the basket in the base year…Say 1995 (c) 2000,2001, 2002 Claudia Garcia - Szekely

  14. Cost of the Basket in the Base Year (1995) Note: Same items, same quantities, same qualities we used for 2000 2 Tuitions $20,000/ea 1 Computer $1,500/ea 5 Doctor visits $90/ea 3 tickets $500/ea $450 $1,500 $43,450 $40,000 $1,500 (c) 2000,2001, 2002 Claudia Garcia - Szekely

  15. The CPI 5. Compute the CPI. Cost of Basket in 2000 x100 CPI (Year 2000) = Cost of Basket Base Year (c) 2000,2001, 2002 Claudia Garcia - Szekely

  16. Calculating the CPI • Fix the quantities and items in the basket. • Find the prices of these items. • Compute the cost of the items in the basket at each year’s prices. • Choose a base year -the benchmark for comparison- Cost of Basket in 2000 x100 CPI (Year 2000) = Cost of Basket Base Year (c) 2000,2001, 2002 Claudia Garcia - Szekely

  17. Updating the Market Basket • 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. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  18. The CPI: Example (c) 2000,2001, 2002 Claudia Garcia - Szekely

  19. The CPI: Example Base Year (c) 2000,2001, 2002 Claudia Garcia - Szekely

  20. Use 4 units of X and 2units of Y as the representative quantities (the basket) Base Year (c) 2000,2001, 2002 Claudia Garcia - Szekely

  21. Calculate Cost of basket in each year… = + X X + = X X + X = X (c) 2000,2001, 2002 Claudia Garcia - Szekely

  22. Year Cost of the Basket CPI 2000 8 (8/8)*100 = 100 2001 14 (14/8)*100 = 175 2002 20 (20/8)*100 = 250 CPI = Basket cost Year X /Basket cost base year. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  23. Calculating the Inflation Rate 175 - 100 X100 = 75% 100 250 - 175 X 100 = 43% 175 (c) 2000,2001, 2002 Claudia Garcia - Szekely

  24. 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. (c) 2000,2001, 2002 Claudia Garcia - Szekely©2001Claudia Garcia-Szekely

  25. The CPI includes • 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).

  26. Although not a “price” CPI includes… • Also included are various government-charged user fees: • water and sewerage charges, auto registration fees, and vehicle tolls. • The CPI also includes taxes: • such as sales and excise taxes that are directly associated with the prices of specific goods and services. • The CPI excludes taxes: • 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: • such as stocks, bonds, real estate, and life insurance. Because these items relate to savings and not to day-to-day consumption expenses. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  27. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  28. Inflation • 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. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  29. Deflation • 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. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  30. 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.. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  31. To compare dollars of different years We either translate today’s dollars into 1930’s or Translate 1930’s dollars into today’s (c) 2000,2001, 2002 Claudia Garcia - Szekely©2001Claudia Garcia-Szekely

  32. Moving dollar values forward in time… CPI (1930) = 16.7 CPI (2000) = 172.2 1930 2000 Multiply by 10.31 (172.2)/(16.7) =10.31 ? $1,031 $100 Prices in 2000 are 10.31 times larger than in 1930 You need to have 10.31 times as much money in 2000 (c) 2000,2001, 2002 Claudia Garcia - Szekely

  33. Moving dollar values back in time… CPI (1930) = 16.7 CPI (2000) = 172.2 1930 2000 Divide by 10.31 (172.2)/(16.7) =10.31 $100 $ 9.70 ? Prices in 1930 were one tenth what they are in 2000 You need a tenth of the money in 1930 (c) 2000,2001, 2002 Claudia Garcia - Szekely

  34. Example If you want to know what is the equivalent in today’s dollars of an $80,000 salary in 1931, • Find the ratio of prices: CPI in 2000 / CPI in 1931 = 172.2/16.7 = ___ • Multiply 80,000 by that # =________ An $80,000 salary in 1931 is equivalent to a $_________salary in 2000. 10.31 824,910.2 824,910.2 (c) 2000,2001, 2002 Claudia Garcia - Szekely

  35. 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? (c) 2000,2001, 2002 Claudia Garcia - Szekely

  36. Inflation Calculator This site finds the equivalencies for dollars in different years. http://data.bls.gov/cgi-bin/cpicalc.pl (c) 2000,2001, 2002 Claudia Garcia - Szekely©2001Claudia Garcia-Szekely

  37. Problems Measuring the Cost of Living • Substitution Bias: Because the basket is fixed, the CPI does not account for substitutions consumers do in response to higher prices. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  38. Geometric Mean Estimator Employs a set of fixed expenditure proportions as weights in averaging the prices of individual items within a CPI basic index. Fixing the relative expenditure proportions rather than the relative quantities implies that consumers can alter the quantities of goods and services they buy within the narrow range of a CPI category, when the relative prices of those goods and services change. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  39. Problems with CPI… • New Goods Bias: new goods mean greater variety and thus consumers need to spend less to attain the same (or higher) standard of living. CPI does not reflect this change in the purchasing power of a dollar. • Unmeasured Quality change: If quality improves, the value of the dollar rises. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  40. More Information on the CPI Go to http://www.bls.gov/cpi/ Table 1. Consumer Price Index for All Urban Consumers (CPI-U): U.S. city average, by expenditure category and commodity and service group. The table is at:http://www.bls.gov/news.release/cpi.t01.htm Print (c) 2000,2001, 2002 Claudia Garcia - Szekely

  41. The GDP Deflator vs. The CPI GDP Deflator reflects the prices of all goods and services produced domestically bought by consumers, the government and other countries. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  42. The GDP Deflator vs. The CPI 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. (c) 2000,2001, 2002 Claudia Garcia - Szekely

  43. 5 1 3 2 The GDP Deflator vs. The CPI • The CPI uses a fixed basket whereas the GDP deflator uses prices of currently produced goods. (c) 2000,2001, 2002 Claudia Garcia - Szekely

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