1. Principles of Macroeconomics
PowerPoint Presentations for
Principles of Macroeconomics
Sixth Canadian Edition
by Mankiw/Kneebone/McKenzie
Adapted for the
Sixth Canadian Edition by
Marc Prud’homme
University of Ottawa

2. Measuring the cost of living
Chapter 6
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3. MEASURING THE COST OF LIVING
The consumer price index is used to monitor changes in the cost of living over time.
When the consumer price index rises, the typical family has to spend more dollars to maintain the same standard of living.
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4. MEASURING THE COST OF LIVING
Economists use the term inflation to describe 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.
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5. THE CONSUMER PRICE INDEX
The consumer price index (CPI): the overall measure of the cost of the goods and services bought by a typical consumer
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6. How the Consumer Price Index Is Calculated
Every month, Statistics Canada computes and reports the CPI.
It uses data on the prices of more than 600 different goods and services.
To see how these statistics are constructed, a simple economy with two goods, hot dogs and hamburgers, is used.
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7. How the Consumer Price Index Is Calculated
Five steps to compute the inflation rate:
Determine the basket.
Find the prices.
Compute the basket’s cost.
Choose a base year and compute the index.
Compute the inflation rate.
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8. TABLE 6.1: Calculating the CPI and the Inflation Rate
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9. How the Consumer Price Index Is Calculated
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10. FYI: What Is in the CPI Basket?
Figure 6.1:
The Basket of Goods and Services
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11. Copyright © 2014 by Nelson Education Ltd.
Active Learning
Calculate the CPI
CPI basket: {10 kg beef, 20 kg chicken}
The CPI basket cost $120 in 2008, the base year.
price of beef
price of chicken
2008 $4
2009 $5
2010 $9 $6
A. Compute the CPI in 2009.
B. What was the CPI inflation rate from ?
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12. Copyright © 2014 by Nelson Education Ltd.
Active Learning
Answers
CPI basket: {10 kg beef, 20 kg chicken}
The CPI basket cost $120 in 2008, the base year.
price of beef
price of chicken
2008 $4
2009 $5
2010 $9 $6
A. Compute the CPI in 2009:
Cost of CPI basket in = ($5 x 10) + ($5 x 20) = $150
CPI in 2009 = 100 x ($150/$120) = 125
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13. Copyright © 2014 by Nelson Education Ltd.
Active Learning
Answers
CPI basket: {10 KG beef, 20 KG chicken}
The CPI basket cost $120 in 2008, the base year.
price of beef
price of chicken
2008 $4
2009 $5
2010 $9 $6
B. What was the inflation rate from ?
Cost of CPI basket in 2010 = ($9 x 10) + ($6 x 20) = $210
CPI in 2010 = 100 x ($210/$120) = 175
CPI inflation rate = (175 – 125)/125 = 40%
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14. Problems in Measuring the Cost of Living
Commodity substitution bias
Introduction of new goods
Unmeasured quality change
Taken together, these sources of bias cause the CPI to overstate the cost of living by 0.6 percentage points a year according to the Bank of Canada.
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15. Problems in Measuring the Cost of Living
Don't inflate inflation
Special to the Financial Post, Financial Post
Wednesday, February 16, 2011
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16. The GDP Deflator versus the Consumer Price Index
The GDP deflator reflects the current level of prices relative to the level of prices in the base year.
Economists and policy makers monitor both the CPI and the GDP deflator to gauge how quickly prices are rising.
Two differences:
The GDP deflator reflects prices of goods and services produced domestically.
The GDP deflator compares the price of currently produced goods and services with the price of the same goods and services produced during the base year.
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17. FIGURE 6.2: Two Measures of Inflation
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18. CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION
The purpose of measuring the overall level of prices in the economy is to permit comparison between dollar figures from different points in time.
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19. Dollar Figures from Different Times
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20. FYI: BoC Inflation Calculator
A basket of goods and services that cost $100 in would cost how much in 1973? In 1983? In 1993? In 2003? In 2013?
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21. Case Study: Mr. Index Goes to Hollywood
What is the most popular movie of all time?
Gone with the Wind!
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22. Copyright © 2014 by Nelson Education Ltd.
Indexation
Indexation: the automatic correction of a dollar amount for the effects of inflation by law or contract
COLA: A COLA automatically raises the wage when the CPI raises.
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23. Real and Nominal Interest Rates
Interest rates involve comparing amounts of money at different points in time.
To fully understand interest rates, knowing how to correct for the effects of inflation is important.
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24. Real and Nominal Interest Rates
Suppose that you make a deposit of $1000 in a bank account that pays interest at a rate of 10 percent per year.
After one year, that bank account now contains $1100 (= Principal of $ Interest of $100).
Are you actually wealthier after one year?
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25. Real and Nominal Interest Rates
Nominal interest rate: the interest rate that is usually reported without a correction for the effects of inflation
Real interest rate: the interest rate that is corrected for the effects of inflation
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26. Copyright © 2014 by Nelson Education Ltd.
QuickQuiz
Henry Ford paid his workers $5 a day in
If the U.S. consumer price index was 10 in and 195 in 2012, how much is the Ford paycheque worth in 2012?
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27. Case Study: Interest Rates in the Canadian Economy
Figure 6.3: Real and Nominal Interest Rates
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28. Classroom Activity Create a Student Price Index Take-Home Assignment
Pick real transactions prices for goods that you actually purchase. If the indices will be used to calculate the inflation rate, you should save a copy of this assignment in a safe place. You should not use prices from catalogues since such prices won’t be subject to change over the semester.
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29. Classroom Activity Create a Student Price Index (continued)
Your mission: Make up a personalized student price index.
Choose five (or more) different products—be specific, for example: unleaded gasoline, Molson Canadian beer
Pick a quantity for each product—for example, 15 litres of gasoline, a 12-pack of Molson Canadian beer
Find the actual price for each product.
Calculate the total cost of buying these products.
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The end
Chapter 6
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