# Shared Flashcard Set

## Details

Ch 6:CPI & The Cost of Living
Unit 2 - Foundations of Macroeconomics
43
Economics
01/22/2008

## Additional Economics Flashcards

Term
 Consumer Price Index (CPI)
Definition
 A measure of the average of the prices paid by the households for a fixed basked of consumer goods and servicesThe major purpose of CPI is to measure changes in the cost of living and in the value of money
Term
 Base Period
Definition
 A period for which the CPI is defined to equal 100. Currently the base period is 1992
Term
 What are the 3 stages of constructing a CPI?
Definition
 Selecting the CPI basketConducting the monthly price surveyCalculating the CPI
Term
Definition
 Contains the goods and services represented in the index and the relative importance attached to each of themThe idea is to make the relative importance of the items in the CPI basket the same as in the budget of an average household
Term
 What are the 2 baskets that Statistics Canada uses to calculate CPI?
Definition
 CPI-All-ItemsCPI-All-Items excluding the 8 most volatile components
Term
 CPI-All-Items
Definition
 Measures the average of the prices paid by all households and covers all goods and services
Term
 CPI-All-Items excluding the 8 most volatile items
Definition
 These volatile items include:prices of fruits vegetablesnatural gas and oilgasolineinter-city transportationtobacco productssmoker's supplies mortgage interest cost
Term
 What are the steps in calculating CPI?
Definition
 Find the cost of the CPI basket at the base period pricesFind the cost of CPI basket at current period pricesCalculate the CPI for the base period and the current period
Term
 What is the formula to calculate CPI?
Definition
 CPI=Cost of CPI basket at current period prices x 100    Cost of CPI basket at base period prices
Term
 Inflation Rate
Definition
 To measure changes in CPI, we calculate inflation rateIs the percentage change in the price level from one year to the next
Term
 What is the formula to calculate inflation rate?
Definition
 Inflation Rate=(CPI in the current year - CPI in Previous year) x 100CPI in Previous year
Term
 Nominal Wage Rate
Definition
 Also called money wage rateThe average hourly wage rate measured in current dollars
Term
 Real Wage Rate
Definition
 The average hourly wage rate measured in the dollars of a given base year
Term
 What is the major difference between the real wage rate and nominal wage rate?
Definition
 Real Wage Rate:Because we measure the real wage rate in constant base-year dollars, a change in the real wage rate measures the change in the quantity of goods and services that an hour's work can buyReal Wage rate takes the effect of inflation out of changes in nominal wage rateIs a significant economic variable because it measures the real reward and cost for labour, which is a major determinant of the standard of livingNominal Wage RateIn contrast, a change in the nominal wage rate measures a combination of a change in the quantity of goods and services than an hour's work can buy and a change in the price level.This rate includes inflation rate
Term
 Nominal Interest Rate
Definition
 The percentage return on a loan expressed in dollars
Term
 Real Interest Rate
Definition
 The percentage return on a loan expressed in purchasing power
Term
 How do we convert nominal interest rate to a real interest rate?
Definition
 Real Interest rate= Nominal rate—Inflation rate
Term
 Why is it important to make a distinction between Nominal & Real Values?
Definition
 Because as a consumer, we can be crucially affected by these same distinctions over the coming years
Term
 Expected Inflation Rate
Definition
 The inflation rate that people forecast and use to make decisionsBoth the nominal interest rate and nominal wage rate are influenced by the expected inflation rate
Term
 How does the inflation affect the real interest rate and the real wage rate? Explain
Definition
 When inflation rate exceeds expected inflation rate, the real interst rate and real wage rate falls. People spend more, firms hire more labour and produce more - the economy expandsWhen inflation rate is less than expected inflation rate, the real interest rate and the real wage rate rises. People spend less, firms hire less labour and produce less and the economy shrinks
Term
 Cost of Living Index
Definition
 A measure of changes in the amount of money that people would need to spend to achieve a given standard of livingIs also sometimes referred to as CPI. But CPI does not measure the cost of living.
Term
 What are the two reasons why CPI does not measure the cost of living?
Definition
 CPI does not try to measure all the components of the cost of livingEven those components of the cost of living that are included in the CPI are not always measured accurately. The result is that CPI is possibly a biased measure of changes in the cost of living
Term
 What are the main sources of bias in the CPI?
Definition
 New goods biasQuality change biasCommodity substitution biasOutlet substitution bias
Term
 New Goods Bias
Definition
 New goods keep replacing the old ones. For ex. Videocassette player and DVD of today Which has a better value
Term
 Quality Change Bias
Definition
 Most items get better every year. But is the improvement in quality greater than the cost?
Term
 Commodity Substitution Bias
Definition
 Changes in relative prices lead consumers to change the items they buy
Term
 Outlet Substitution Bias
Definition
 When confronted with higher prices, people use discount stores more frequently and less of the convenience stores.
Term
 What are the two consequences of the CPI bias?
Definition
 Distorst private contractsIncreases government payments
Term
 Explain what the Consumer Price Index (CPI) is and how it is calculated
Definition
 P.89
Term
 Adjust money values for inflation and calculate real wage rates and real interest rates
Definition
 P.89
Term
 Explain the limitations of the CPI as a measure of cost of living
Definition
 P.89
Term
 Explain the consequences of the CPI bias for private agreements & government payments.
Definition
Term
 Compare the GDP Deflator and the CPI as measures of cost of living
Definition
Term
 How do we convert a nominal value to a real value?
Definition
 Real Value=Price at year being comparedxCPI at current year÷CPI at year being compared
Term
 Nominal Value
Definition
 Is a value expressed in current dollars
Term
 Real Value
Definition
 IS the value expressed in the dollars of a given year
Term
 What is the formula to calculate Real GDP?
Definition
 Real GDP=Nominal GDP ÷GDP Deflator
Term
 What are the Nominal and Real Values Distinctions in Macroeconomics?
Definition
 A Nominal value is expressed in current dollars vs Real value expressed in dollars at a given time periodNominal GDP vs. Real GDPCPI vs. GDP DeflatorNominal Wage Rate vs. Real Wage rateNominal Interest Rate vs. Real Interest Rate
Term
 What is the formula to calculate Real Wage Rate?
Definition
 Real Wage Rate=Nominal wage rate÷GDP Deflatorx100%
Term
 What is the formula to calculate Real Interest Rate?
Definition
 Real Interest Rate=Nominal Interest Rate-Inflation Rate
Term
 True or False Nominal Interest Rate and nominal wage rate are influenced by the expected inflation rate
Definition
 T
Term
 How does expected inflation rate affect production?
Definition
 When inflation rate exceeds the expected inflation rate, real wage rate and real interest rate falls. So people spend more, firms hire more labour and produce more and the economy expands When inflation rate is less than the expected inflation rate, real wage rate and interest rate rise. People spend less, firms hire less labour and produce less and the economy shrinks
Term
 In 1996, a study conducted estimates that the U.S CPI overstate inflation by _____ percentage points a year.
Definition
 1.1
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