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What does Inflation Rate Reveal About an Economy’s Health?

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

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