PRINCIPLES OF MACROECONOMICSText: Principles of Macroeconomics, N. Gregory Mankiw, Sixth Edition.

Instructor: Sue Guzek, Kansas State University Salina

Music: We Gonna Make You… By Troy “Trombone Shorty” Andrews and Orleans Avenue – Orleans and Claiborne

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MEASURING THE COST

OF LIVING – PART A

CPI

WHAT IS CPI?

2

Overall cost

Of goods and

services

Bought by a typical

consumer

WHY CPI?

3

INFLATION

4

% change in price level from a previous period

Impacts economic policy

GDP = Current production

GDP Deflator measures inflation as

= Nominal GDP

Real GDP

X 100

CPI = Current purchases

Most common gauge of inflation

THE CPI BASKET FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full

service meals, 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, toys, 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).

Payments to governments: MV registration fees and tolls, water, sewer, sales and excise tax

Exclusions: income and SSI tax, investments,

Source: US Bureau of Labor Statistics: http://www.bls.gov/cpi/cpifaq.htm#Question_6 5

THE CPI BASKET

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41%

17%

15%

7%

7%

6%

4%3%

CPI Percentages 2012

Housing

Transportation

Food and Beverage

Medical care

Education andcommunicationRecreation

Apparel

Other

HOW CPI IS CALCULATED

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1. Fix the basket

2. Find Prices

3. Compute Value

4. Choose base year

and compute CPI

5. Compute inflation

rate

2 frozen pizzas X $5 = $10

CPI = (Current Year price / base year price) X 100

Inflation Rate= ((CPI yr 2 – CPI yr 1)/CPI yr 1) X

100

EXAMPLE

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• Fix the basket, Find Prices, Compute Value

Example: Food for a family of 4, 2 adults, 2 children,

Year Basket

Price

1980 $4350

2010 $9480

2011 $9830

2012 $10000

http://www.cnpp.usda.gov/Publications/FoodPlans/2012/CostofFoodJan2012.pdf

CPI = (Current year Price of basket/base year price ) X

100

4. Choose base year and compute index

Formula CPI

= 4350/4350 X 100 100

= 9480/4350 X 100 218

= 9830/4350 X 100 226

=10000/4350 X 100 230

$833 per month or a 2012 value of basket = $10,000

EXAMPLE SLIDE 2

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1. Fix the basket

2. Find Prices

3. Compute Value

4. Choose base year and compute

index

5. Compute inflation

rate

Year CPI Formula % Increase

1980 100

2010 218

2011 226 =((226-218)/218)*100 3.7%

2012 230 =((230-226)/226)*100 1.7%

Inflation Rate= ((CPI yr 2 – CPI yr 1)/CPI yr 1) X 100

HISTORY - CPI

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PROBLEMS WITH USING CPI

Substitution bias

Introduction of new

goods

Unmeasured quality

change

11

TERMS AND CONCEPTS

12

Consumer Price Index

Inflation rate

LEARNING OBJECTIVES

Explain how the Consumer Price Index

(CPI) is built and calculated

List the challenges with use CPI to

measure the cost of living

13

OTHER SOURCES

See also the insets in the Mankiw text

including

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SOURCES

Principles of Macroeconomics, N. Gregory Mankiw, Sixth Edition: PowerPoint Slides prepared by: Andreea CHIRITESCU, Eastern Illinois University

US Bureau of Labor Statistics: http://www.bls.gov/cpi/cpifaq.htm#Question_6

US Dept of Agriculture: http://www.cnpp.usda.gov/Publications/FoodPlans/2012/CostofFoodJan2012.pdf

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