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MEASURING THE COST OFLIVING

MACRO ECONOMICS

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Overview

Learn how the Consumer Price Index (CPI) isconstructed.

Calculating Consumer Price Index and the

Inflation Rate.Problems in measuring the cost of living.

Correcting economic variables for the effects of

inflation.

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Measuring the Cost of Living

In determining the cost of living, Statistics BDfirst identifies a market basket of goods and

services the typical consumer buys.

Annually, Statistics BD surveys consumers to

determine what they buy and the overall cost of

the goods and services they buy.

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Measuring the Cost of Living

The

Consumer

Price Index

(CPI) is used tomonitor changes in the cost of living (i.e. the

selected market basket) over time. When the CPI

rises, the typical family has to spend more dollarsto maintain the same standard of living.

The goal of the CPI is to measure changes in the

cost of living. It reports the movement of prices

not in dollar amounts, but with anindex number.

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What is an Index Number?

An

Index

Number is developed with anarbitrary base (usually starting with 100)

that indicates a change in magnitude

relative to its value at a specified point intime.

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Overview

Learn how the Consumer Price Index (CPI) is

constructed.


Inflation Rate.

Problems in measuring the cost of living.


inflation.

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Calculating the Consumer Price Index

and the Inflation Rate

Determine what goods are most important to thetypical consumer: FixtheBasket

Find the prices of each of the goods and

services in the basket for each point in time:FindthePrices

Use the data on prices to calculate the cost of

the basket of goods and services at differenttimes: ComputetheBasketsCost

Designate one year as the Base Year, which is

the benchmark for yearly comparison.

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Calculating the Consumer Price Indexand the Inflation Rate

The final step includes using the CPI tocalculate theInflation Rate, which is:

the percentage change in the price index from

the preceding periodExample:Base Year is 2000

Bundle of goods in 2000 = $1,200The same bundle in 2002 cost = $1,272

CPI = ($1,272 $1,200) X 100 = 106

Prices between 2000 & 2001 increased 6%

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10

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Inflation ??

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Inflation Inflation rate : The percentage change in the price

index from the preceding period. Two types of Inflation rate in Bangladesh : Food

Inflation & non-food Inflation

Inflation rate in Year 2 = CPI in Year 2-CPI in Year 1 x100

CPI in Year 1

Inflation 2013-14

Food-Inflation 8.56

Non-Food Inflation 5.55

General 7.35

Table 1 (Source: Bangladesh Bureau of Statistics, 2014). Also see :Figure 3 for CPI data

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Other Price Indexes

Other Price Indexes are computed for:Specific regions within the country (e.g. each

District and for 6 cities across Bangladesh)

Narrow categories of goods and services

(e.g. food, clothing, etc.)

Producer costs of resources (i.e. industrialproduct price index)

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Overview

Learn how the Consumer Price Index (CPI) is

constructed.


Inflation Rate.

Problems in measuring the cost of living.


inflation.

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Problems in Measuring The Cost of

Living

The CPI is an accurate measure of the selected

goods that make up the typical bundle,but it is

not a perfect measure of the costof living.

Three reasons/problems:

Substitution Bias

Introduction of new goods

Unmeasured quality change

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CPI for Bangladesh Bangladesh Bureau of Statistics (BBS) computes

National Consumer Price Index (CPI)using foodand non-food commodities basket and services

consumed by the consumers in their day-to-day

life. In order to construct the price index, the

commodity and weight of the index basket from

the Household Income and Expenditure Survey

(HIES) 2005-06 is used. All rural and urban price

indices were compiled using the lists of consumer

goods of rural and urban households based on the

survey.

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CPI for Bangladesh

And finally, the national price index is computed

by taking into account the weighted average ofconsumption expenditures of the two areas.

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P Sh f F d E di

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Percentage Share of Food ExpenditureYear 2010 2005

Total Food Expenditure (in Tk.) 6031 3209

% of Total 100 100Cereals 35.95 39

Pulses 2.35 2.65

Fish 13.71 12.24

Meat & eggs 10.31 8.51Vegetables 7.79 8.38

Milk/Milk Products 3.02 3.74

Edible oil 4.35 4.25

Condim/Spices 9.99 7.52

Fruits 4.08 3.23

Sugar/Gur 1.06 1.56

Beverage 0.73 0.68

Miscellanies 5.67 8.25

Figure 2(Source: Chapter 4, HIES(Household Income and Expenditure Survey) 2010,Bangladesh Bureau of Statistics )

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Problems of CPI: Substitution Bias

The bundle does not change in the short run to

reflect consumer reaction to changing relative

prices.

Consumers substitute toward goods that have

become relatively less expensive.

CPI is computed assuming a fixed basket of

goods.The index overstates the increase in cost of

living by not considering the substitution by the

consumer.

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Problems of CPI: New Goods

The bundle does not reflect the effects of new

products that typically go down in price after

introduction.

New products result in greater variety, which in turn

makes each dollar more valuable. Consumers need

fewer dollars to maintain any given standard of

living.

The CPI is based on a fixed basket of goods and

does not reflect the change in the purchasing power

of the dollar.

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Problems of CPI: Quality Changes

Higher market prices usually include quality

changesthatdonotnecessarilyrepresentahigher

costofliving.

If the quality of a good decreases from one yearto the next, the value of a dollar falls, even if the

price of the good stays the same.

The true cost of living may be less even though

some goods cost more.

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Problems of CPI

The substitution bias, introduction of new goods,

andunmeasuredqualitychangescausetheCPIto

overstatethetruecostofliving.

The issue is important because manygovernment programs use the CPI to adjust for

changes in the overall level of prices.

The CPI overstates inflation by about 1

percentage point per year

Th C P i I d VS

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GDP deflator & CPI give some what different

information about whats happening to the

overall level of prices in the economy. Three Key Differences:

1. GDP deflator measures the prices of all goods and

services produced

whereas CPI measures the prices of only the

goods and services bought by consumers

The Consumer Price Index VS

The GDP Deflator

Th C P i I d VS

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The Consumer Price Index VS

The GDP Deflator

2. GDP deflator includes only those goods produced

domestically. Imported goods are not a part of GDP

and do not show up in the GDP deflator. On the

other hand, CPI include imported goods.

3. CPI is computed using a fixed basket of goods

whereasGDP deflator allows the basket of goods to change

over time as the composition of

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Quick Quiz!

Explain briefly what the consumer price index

is trying to measure and how it is constructed.

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Overview





inflation.

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Correcting Economic Variables for the

Effects of Inflation

Price indexes are used to correct for the effects

of inflation when comparing dollar figures from

different times.

When some dollar amount is automatically

corrected for inflation by law or contract the

amount is said to beindexedfor inflation.e.g., Real Interest Rate , Inflation adjusted Pension

C ti E i V i bl f

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Correcting Economic Variables forthe Effects of Inflation

To convert (inflate) past wages and prices intocurrent terms:

Current Year Dollars =

Past Year Nominal Value X[(Price index in current

year) (Price index in past year)]

OrAmount in todays Taka= Amount in Year T

Taka

(Price Level today Price level in Year T)

C ti E i V i bl f th

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Correcting Economic Variables for the

Effects of Inflation

To convert (deflate) current wages and pricesinto past year terms:

Value in Past Year Dollars =Current Year Value X[(Price index in past year)

(Price index in current year)]

Example: Salary in 1931 = Salary in 2015 X

[(Price index in 1931) (Price index in 2015)]

80,000 Tk. = 1,026316 Tk. X(15.2195)

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Real and Nominal Interest Rates

Interest represents a payment in the futurefor a transfer of money in the past.

Nominalinterestrate:

The rate that the bank pays in current value.

Realinterestrate:

The interest rate corrected for inflation.

Real interest rate = Nominal - Inflation

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Real and Nominal Interest Rates

ExampleAssume:

You borrow $1,000 for one year.

Nominal Interest rate was 15%.During the year inflation was 10%.

The real interest rate is:

15% - 10% = 5%

Conclusion

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ConclusionWhen comparing dollar values from different

times, it is necessary to keep in mind that a Takatoday is not the same as a Taka in the past.

The CPI illustrates one way that prices are

measured and how to make adjustments for theseprice changes.

One Tk. Value at the Time of Shah-e-sta Khan

compared to Today?

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Overview





inflation.

Effects of Inflations

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Effects of InflationsConsumers Producers Economy

Zero

inflation

Not affected at

all

No incentive to

produce more,

Same production

Stagnant for

almost same

level of

production

Mild

Inflation

Affected but not

much,

Demand may be

same

Have incentive to

produce more,

Higher production

Economy

expands as

production

increase

High

Inflation

Affected much,

Demand may be

lower in many

products

Producers of inelastic

products affected,

Production lower for

lower demand

Economy

squeezes as

production falls

Documents

CPI2 546 - Copy.pdf