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Limitations of the CPI as a Measure of Inflation
Adjusting for Inflation: Nominal vs. Real Cost of Living
The Economic Costs of Inflation
- Substitute bias cannot be accounted for
- Outlet bias- CPI is slow to adjust to people buying at discount stores
- New product bias- new products change the price of old products
- Quality Change Bias- improved quality may increase the price of a product
- The cost of goods should not be measured in dollars, but time spent working to be able to afford the good
- Shoes 1958- $4 Average wage- $2/hour
- Shoes 2014- $40 Average wage- $20/hour
Tracking Inflation with the consumer price index.
- Nominal cost of living: the cost at the current rate
- Real Cost of Living: the cost of goods and services adjusted for inflation
- Nominal Wages: wages based on current prices
- Real Wages: wages adjusted for inflation and compared over time
- Loss of purchasing power
- Costs of goods going up do not allow us to purchase as much
- Standard of living declines as the prices change across multitude of goods.
- Interest rates increase because the repayment of a loan becomes worth less than the initial debt
- Uncertainty about prices creates uncertainty in the market
- The BLS tracks the average changes of a type of good over time.
- 25,000 stores are visited and prices are recorded