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ECN 202: Principles of Macroeconomics Nusrat Jahan Lecture-3

ECN 202: Principles of Macroeconomics Nusrat Jahan Lecture-3. Measuring the Cost of Living. Inflation refers to a situation in which the economy’s overall price level is rising. The inflation rate is the percentage change in the price level from the previous period . Inflation.

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ECN 202: Principles of Macroeconomics Nusrat Jahan Lecture-3

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  1. ECN 202: Principles of MacroeconomicsNusrat JahanLecture-3 Measuring the Cost of Living

  2. Inflation refers to a situation in which the economy’s overall price level is rising. • The inflation rate is the percentage change in the price level from the previous period Inflation • Consumer Price Index (CPI) • The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer.

  3. How To Calculate The CPI? • Fix the basket a typical consumer will buy. • Find the prices of the items for different years. • Compute the basket’s cost for each year. • Choose a base year. • Calculate the cost of the basket for other years in terms of the base year. • Calculate inflation rates.

  4. CPI Calculation • Computation of the inflation rate

  5. => Computation of Inflation Rate using GDP Deflator • Problems in Calculating Cost of Living • Substitution bias • Introduction of new goods • Unmeasured quality change • Difference Between Calculating Inflation Using CPI and GDP Deflator • 1. GDP deflator reflects the prices of all goods and services produced domestically, whereas the consumer price index reflects the prices of all goods and services bought by consumers. • 2. The consumer price index compares the price of a fixed basket of goods and services to the price of the basket in the base year. By contrast, the GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year.

  6. Real and Nominal Interest Rates • The nominal interest rate is the interest rate usually reported and not corrected for inflation. • It is the interest rate that a bank pays. • The real interest rate is the nominal interest rate that is corrected for the effects of inflation.

  7. Real and Nominal Interest Rates • You borrowed $1,000 for one year. • Nominal interest rate was 15%. • During the year inflation was 10%. Real interest rate = Nominal interest rate – Inflation =15% - 10% = 5%

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