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Consumer Price Index

Consumer Price Index. What prices have changed over your lifetime?. What items cost more? What items cost less?. Question: How do we know if something “really” costs more?. First, we need correct terminology. Nominal price: list or actual cost given current value of money.

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Consumer Price Index

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  1. Consumer Price Index

  2. What prices have changed over your lifetime? What items cost more? What items cost less?

  3. Question: How do we know if something “really” costs more?

  4. First, we need correct terminology.

  5. Nominal price:list or actual cost given current value of money

  6. Nominal price:Useful for comparisons within same time periodand in same location

  7. Problem with nominal prices:Cannot make meaningful comparisons of prices across time periods or locations.

  8. Prices of products in 1962: • $0.05 for a Hershey bar • $0.05 for a copy of New York Times • $0.04 for first class postage stamp • $0.31 for gallon of regular gas • $0.28 for McDonalds double hamburger • $2,529.00 for full-size Chevrolet

  9. Why can’t one compare 1962 prices with prices for same or similar products today? More precisely, why are such comparisons meaningless?

  10. Real price:Cost relative to general economic conditions in a place and time.

  11. Why?Because the price of an item only has meaning in terms of what one passes up to buy it.

  12. Similarly with wages:Income only can be evaluated in terms of what can be purchased with it.

  13. Inflation:A general rise in prices in an economy.

  14. Deflation:A general decrease in prices in an economy.

  15. Inflation and deflationcreate disparities between real and nominal prices.

  16. Suppose a young person gets an allowance of $10 per week. Her allowance allows her a certain level of consumption.

  17. Suppose that the prices of goods she normally buys increase by 20% and her father increases her allowance to $11.

  18. Has her allowance increased?

  19. Answer:Her nominal allowance has increased buther real allowance has decreased.

  20. Key Question: Are people better off now than they used to be?

  21. To answer this, you need a way to standardize prices (and wages), so that you can compare across time.

  22. CPI: Consumer Price Index • Economists use Consumer Price Index [CPI] to estimate real wages and costs from nominal wages and costs.

  23. Computation of CPI • An army of economists gathers prices on a standard “market basket” of goods at fixed time periods (month, year)

  24. Computation of CPI • An army of economists gathers prices on a standard “market basket” of goods at fixed time periods (month, year). • The prices of the baskets is compared.

  25. Computation of CPI • An army of economists gathers prices on a standard “market basket” of goods at fixed time periods (month, year). • The prices of the baskets is compared. • The prices are converted to index numbers.

  26. What’s in the CPI? • Housing (41.4%) • Transportation (17.8%) • Food (16.2%) • Energy (8.2%) • Medical Care (6.4%) • Apparel & Upkeep (6.1%) • Other (3.9%)

  27. Current CPI • NYTimes Graphic

  28. Creating the CPI • Cost of bundle in a base year = 100 (on index) • Cost of the bundle for other years is then calculated • Ex: 1982 = base year; bundle = $1103.46 • In 1983, bundle = $1138.91 • SO: $1138.91 (1983) = $1103.46 (1982)

  29. OR: • $1138.91 (1983) = $1103.46 (1982) • Then 1 (1982$) = 1138.91/1103.46 =1.032 (1983$) • So…1 (1982$) = 1.032 (1983$) • 1982 = base year; index = 100 • 1983; index = 103.2

  30. Year 1980 1981 1982 1983 1984 1985 1986 1987 CPI 85.4 94.2 100.0 103.2 107.7 111.5 113.6 117.7 And we get an INDEX

  31. FORMULA for the Conversion Factor • Notice that those relative values can be computed using this formula:CPI of base year / CPI of object year (Object year is the year being compared to the base year)

  32. Conversion factor = CPI of base year / CPI of object year

  33. Use the conversion factor to adjust the prices:Price * conversion factor = adjusted price

  34. An Example • 1990, gas costs $1.16/gallon (on avg) • 1997, gas costs $1.23/gallon (on avg) • Was gas more or less expensive in 1997? • Nominal price (current price) = MORE • But, what about in constant/real $?

  35. Converting Prices • From the CPI table, we know that $130.70 (1990) = $160.50 (1997) If something costs $1.16 in 1990, what would that amount to in 1997? 160.50 (1997) = x (1997 $) 130.70 (1990) 1.16 (1990 $)

  36. Another way to think of this • Conversion Factor • = CPI of base year/CPI of object year 160.50 130.70 (how much more one dollar in 1990 is worth in 1997) =1.228 * $1.16 = $1.42 So, $1.16 in 1990 = $1.42 in 1997

  37. Using previous terminology:Nominal price * conversion factor = real price (relative to base year)

  38. Combining the formula for adjusted price with that for the conversion factor:Nominal price * (CPI base year / CPI object year) = real price

  39. Another Example

  40. Converting Prices in Excel

  41. Freezing the Cell • Remember that you can “freeze” the value in a cell so that the reference stays the same • When you convert prices, you want to freeze the value of the base year (1998) • F4 freezes the value – B2*$C$10/C2

  42. Additional terminology: • Current values (prices, wages, etc.) are prices (nominal values) at the value of the currency at that time • Constant values (prices, etc.) are prices in real values, i.e., as if the currency had the value of the base year.

  43. Inflation Rate • Percentage Change in the annual CPI • Ex: Inflation Rate in 1996:

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