011_Measuring the Cost of Living
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Transcript of 011_Measuring the Cost of Living
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Government, Business and Society
Measuring Cost of Living
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Module- 2 Macroeconomic Framework
Contents National Income Analysis: Circular flow of Income,
Concepts of national income and measurement. Consumption Function, Investment Function,
Concept of Multiplier and Accelerator, Aggregate Demand & Aggregate Supply National Income Equilibrium, Inflationary & Deflationary gaps, Real Business cycles, Application of above in business and society.
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How we calculate overall cost of living?
Converting monetary figures into meaningful purchasing power
Consumer price index Inflation describe a situation in which economys
overall price level is rising. Inflation rate is percentage change in the price
level from previous period.
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The Consumer Price Index
Consumer price index (CPI) Measure of the overall level of prices Measure of the overall cost of goods and
services Bought by a typical consumer
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Calculating CPI 1. Fix the basket
Which prices are most important to the typical consumer
Different weight 2. Find the prices
At each point in time 3. Compute the baskets cost
By keeping same basket of goods effects of price changes is isolated
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Calculating CPI 4. Chose a base year and compute the index
Base year = benchmark Price of basket of goods & services in current year Divided by price of basket in base year Times 100
5. Compute the inflation rate
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1001year in CPI
1year in CPI-2year in CPI2year in rateInflation =
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Calculating the Consumer Price Index and the Inflation Rate: An Example
This table shows how to calculate the consumer price index and the inflation rate for a hypothetical economy in which consumers buy only hot dogs and hamburgers.
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Calculating the Consumer Price Index and the Inflation Rate: An Example
This table shows how to calculate the consumer price index and the inflation rate for a hypothetical economy in which consumers buy only hot dogs and hamburgers.
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The Typical Basket of Goods and Services
This figure shows how the typical consumer divides spending among various categories of goods and services. Economists calls each percentage the relative importance of the category.
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Inflation- Other measures Producer price index, PPI
Measure of the cost of a basket of goods and services bought by firms
Changes in PPI are often thought to be useful in predicting changes in CPI
Wholesale price index, WPI Captures the movements in the wholesale prices ; Very
close to the PPI Differs from the PPI to the extent of tax, wholesale
margin and transport cost from manufacturing units to wholesale establishment
Many countries have switched over from the WPI to PPI Because the PPI can track price changes at primary and intermediate stages before it gets built into the finished goods stages
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Problems in measuring the cost of living
Substitution bias Prices do not change proportionately Consumers substitute toward goods that have
become relatively less expensive Overstates the increase in cost of living from one year to
next
Introduction of new goods More variety of goods
Unmeasured quality change Changes in quality
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GDP deflator versus CPI
GDP deflator Ratio of nominal GDP to real GDP Reflects prices of all goods & services produced
domestically Compares the price of currently produced goods
and services to the price of the same goods and services in the base year
CPI Cost of the basket- Reflects prices of goods &
services bought by consumers Compares price of a fixed basket of goods and
services to the price of the basket in the base year
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Two Measures of Inflation
This figure shows the inflation ratethe percentage change in the level of prices as measured by the GDP deflator and the consumer price index using annual data since 1965. Notice that the two measures of inflation generally move together.
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Correcting Economic Variables Dollar figures from different times
Indexation Automatic correction by law or contract Of a dollar amount For the effects of inflation DA (Dearness allowance or Cost of living
allowance)
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Amount in today's dollarsPrice level todayAmount in year T dollars
Price level in year T
=
=
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Real and Nominal Interest Rates
Nominal interest rate Interest rate as usually reported Without a correction for the effects of inflation
Real interest rate Interest rate corrected for the effects of inflation
= Nominal interest rate Inflation rate
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Interest rates in a typical Economy
Nominal interest rate Always exceeds the real interest rate Economy experiences rising consumer prices in
every year Inflation is variable
Real and nominal interest rates do not always move together
Periods of deflation Real interest rate exceeds the nominal interest
rate
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Real and Nominal Interest Rates
This figure shows nominal and real interest rates using annual data since 1965. The nominal interest rate is the rate on a 3-month Treasury bill. The real interest rate is the nominal interest rate minus the inflation rate as measured by the consumer price index. Notice that nominal and real interest rates often do not move together.
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Price Indices in India
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Price Indices: Sources of Data, Base Year, Commodity Composition and Method of Computation
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WPI CPI-IW CPI-AL CPI-RL CPI-Rural CPI-Urban CPI-Combined (Rural +Urban)
GDP Deflators
Source/ Agency Office of the Economic Advisor/ MOI
Labour Bureau/ MOL
Labour Bureau/ MOL
Labour Bureau/ MOL
CSO NAS, CSO
Method Laspeyres Laspeyres Passche Weights allocated on the basis of
Wholesale transactions
Consumer Expenditure Survey Current year quantities First 1958-59
Latest: 2001 First 1956-57 Latest: 1983
First 1983 Latest 1983
NSS 61st round
Weighting diagram
Country-wide, unique
Horizontal summation of weights of centre specific indices
Price Quotations Bulk transactions Purchase price paid by the consumers - Nature of the index
Single, national Weighted average of the centre indices -
Current Base Year 2004-05 2001 1986-87 2010 2004-05
No of items in basket
676 120-360 260 225 250 n.a. All
Major items covered
i)Primary articles ii)Fuel, power, light & lubricants iii)Manufactured products
i)food ii)Pan, Supari, tobacco& intoxicants iii) fuel&light iv) housing v) clothing, bedding & footwear vi)miscellaneous
i i)food beverages & tobacco ii)fuel & light iii) clothing, bedding & footwear iv)miscellaneous
i)food beverages & tobacco ii)fuel & light iii) clothing, bedding & footwear iv) miscellaneous
i)food beverages & tobacco ii)fuel & light iii) clothing, bedding & footwear iv) housing v) miscellaneous
n.a. All items included in the GNP
No. of Centres/Quotations
5,482 78 600 1181 310 1491 Benchmark surveys
Time Lag 2 weeks/ 1 month 1 month 3 weeks 1 month 2 years
Frequency Weekly: Primary articles and Fuel, power, light & lubricants; Monthly: Overall and all sub-heads
Monthly Yearly
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Price Indices in India Uses of Price Indices
WPI CPI GDP Deflator
Users RBI, Planning Commission, Other govt org
Govt, Pvt org, NGOs
Researchers Government
Purpose Deflating Macroeconomic aggregates
Forecasting variables for which prices are prime indicators
Working out escalation costs of projects
Social security and welfare allowances CPI(IW) : wage & dearness allowances of workers & CPI (RL) & CPI (AL): Fixing minimum wages
Main Use Estimation of Inflation Dearness Allowances
Deflating Macroeconomic Indicators
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WPI
CPI
GDP Deflator
Users
RBI, Planning Commission, Other govt org
Govt, Pvt org, NGOs
Researchers
Government
Purpose
Deflating Macroeconomic aggregates
Forecasting variables for which prices are prime indicators
Working out escalation costs of projects
Social security and welfare allowances
CPI(IW) : wage & dearness allowances of workers &
CPI (RL) & CPI (AL): Fixing minimum wages
Main Use
Estimation of Inflation
Dearness Allowances
Deflating Macroeconomic Indicators
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Price Indices in India WPI Vs CPI
WPI WPI (Overall): available on
monthly frequency WPI (Primary Articles) and WPI
(Fuel Group) available at weekly frequency
Lag of a fortnight Computed on all India basis Coverage of non- agriculture /
manufactured products is better Wider coverage of commodities:
less volatile to relative price
CPI IW Available at monthly
frequency Lag of one month Constructed for specific
centres Some consumer services are
also included Lesser coverage of
commodity: subject to higher volatility
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Price Indices in India
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Government, Business and SocietyModule- 2 Macroeconomic FrameworkSlide Number 3The Consumer Price IndexCalculating CPICalculating CPISlide Number 7Slide Number 8Slide Number 9Slide Number 10Inflation- Other measuresProblems in measuring the cost of livingGDP deflator versus CPISlide Number 14Correcting Economic VariablesSlide Number 16Real and Nominal Interest RatesInterest rates in a typical EconomySlide Number 19Price Indices in IndiaPrice Indices: Sources of Data, Base Year, Commodity Compositionand Method of ComputationPrice Indices in India Uses of Price IndicesPrice Indices in India WPI Vs CPIPrice Indices in India