Measuring the Cost of Living 24 Measuring the Cost of Living 生活费用的衡量 This chapter can probably be covered in 1-1.5 class sessions. It would be helpful if your students had calculators so they can compute a CPI example and an example of using the CPI to compare dollar figures from different years.

In this chapter, look for the answers to these questions: What is the Consumer Price Index (CPI)? How is it calculated? What’s it used for? What are the problems with the CPI? How serious are they? How does the CPI differ from the GDP deflator? How can we use the CPI to compare dollar amounts from different years? Why would we want to do this, anyway? How can we correct interest rates for inflation? 什么是消费物价指数 (CPI)？怎么计算？它有什么用? CPI存在怎样的问题?它们有多严重？ CPI与GDP平减指数有何区别? 我们如何用CPI来比较不同年份相同数量的美元?我们为什么要做这个？ 我们怎样用通货膨胀来校正利率？ 1

The Consumer Price Index (CPI) measures the typical consumer’s cost of living the basis of cost of living adjustments (COLAs) in many contracts and in Social Security 衡量普通消费者的生活成本 在许多合同与社会保障中作为生活费用调整的依据 MEASURING THE COST OF LIVING 2

How the CPI Is Calculated Fix the “basket.” The Bureau of Labor Statistics (BLS) surveys consumers to determine what’s in the typical consumer’s “shopping basket.” Find the prices. The BLS collects data on the prices of all the goods in the basket. Compute the basket’s cost. Use the prices to compute the total cost of the basket. 固定 “篮子” 劳工统计局通过调查消费者找出普通消费者 “购物篮”中的物品 找出价格 劳工统计局收集购物篮中所有物品价格的数据 计算这一篮子东西的费用 用价格数据计算出这一篮子物品的费用 MEASURING THE COST OF LIVING 3

How the CPI Is Calculated Choose a base year and compute the index. The CPI in any year equals 100 x cost of basket in current year cost of basket in base year Compute the inflation rate. The percentage change in the CPI from the preceding period. CPI this year – CPI last year CPI last year Inflation rate x 100% = MEASURING THE COST OF LIVING 4

basket: {4 pizzas, 10 lattes} EXAMPLE basket: {4 pizzas, 10 lattes} $3.00 $2.50 $2.00 price of latte $12 2009 $11 2008 $10 2007 price of pizza year cost of basket $10 x 4 + $2 x 10 = $60 $11 x 4 + $2.5 x 10 = $69 $12 x 4 + $3 x 10 = $78 Compute CPI in each year 2007: 100 x ($60/$60) = 100 2008: 100 x ($69/$60) = 115 2009: 100 x ($78/$60) = 130 using 2007 base year: Inflation rate: Suggestion: Show students the data in the first three columns of the table. Before showing them the cost of basket calculations, tell them to take 3 minutes to compute the cost of the basket in each of the three years, and use those results to compute the value of the CPI in each of the three years. Then, show the rest of the slide. Or, you can just cruise through this example, but tell them to pay close attention because in a few moments they will have to compute a similar example. 15% 115 – 100 100 x 100% = 13% 130 – 115 115 x 100% = MEASURING THE COST OF LIVING 5

A C T I V E L E A R N I N G 1 Calculate the CPI A C T I V E L E A R N I N G 1 Calculate the CPI price of beef price of chicken 2004 $4 2005 $5 2006 $9 $6 CPI basket: {10 lbs 磅beef, 20 lbs chicken} The CPI basket cost $120 in 2004, the base year. A. Compute the CPI in 2005. B. What was the CPI inflation rate from 2005-2006? Part A is not difficult but requires an intermediate step: students must compute the cost of the basket in 2005 to find the CPI in 2005. Part B has two intermediate steps: computing the cost of the basket in 2006, then computing the CPI in 2006. 6

A C T I V E L E A R N I N G 1 Answers A C T I V E L E A R N I N G 1 Answers price of beef price of chicken 2004 $4 2005 $5 2006 $9 $6 CPI basket: {10 lbs beef, 20 lbs chicken} The CPI basket cost $120 in 2004, the base year. A. Compute the CPI in 2005: Cost of CPI basket in 2005 = ($5 x 10) + ($5 x 20) = $150 CPI in 2005 = 100 x ($150/$120) = 125 7

A C T I V E L E A R N I N G 1 Answers A C T I V E L E A R N I N G 1 Answers price of beef price of chicken 2004 $4 2005 $5 2006 $9 $6 CPI basket: {10 lbs beef, 20 lbs chicken} The CPI basket cost $120 in 2004, the base year. B. What was the inflation rate from 2005-2006? Cost of CPI basket in 2006 = ($9 x 10) + ($6 x 20) = $210 CPI in 2006 = 100 x ($210/$120) = 175 CPI inflation rate = (175 – 125)/125 = 40% 8

What’s in the CPI’s Basket? 3% 4% Housing 6% Transportation 6% Food & Beverages 43% 6% Medical care Recreation休闲活动 This slide replicates Figure 1 from the textbook. Source: Bureau of Labor Statistics, http://www.bls.gov/cpi/ This graph shows just a few highly aggregated categories. A more detailed breakdown is available at the BLS website: look for “Relative Importance of Components in the Consumer Price Index” there. Education and 15% communication Apparel服装 17% Other MEASURING THE COST OF LIVING 9

中国CPI八大构成 MEASURING THE COST OF LIVING

A C T I V E L E A R N I N G 2 Substitution bias A C T I V E L E A R N I N G 2 Substitution bias CPI basket: {10# beef, 20# chicken} 2004-5: Households bought CPI basket. 2006: Households bought {5 lbs beef, 25 lbs chicken}. beef chicken cost of CPI basket 2004 $4 $120 2005 $5 $150 2006 $9 $6 $210 Students understand substitution bias better if they work a concrete example like the one on this slide. Before displaying the questions (A + B), you might want to ask your class why households bought different quantities of beef and chicken in 2006 than they did in 2005. Or if that seems too easy, just mention before displaying questions A and B that households are responding to the change in relative prices: beef has become a lot more expensive relative to chicken, so households buy less beef and more chicken. A. Compute cost of the 2006 household basket. B. Compute % increase in cost of household basket over 2005-6, compare to CPI inflation rate. 11

A C T I V E L E A R N I N G 2 Answers CPI basket: {10# beef, 20# chicken} Household basket in 2006: {5# beef, 25# chicken} beef chicken cost of CPI basket 2004 $4 $120 2005 $5 $150 2006 $9 $6 $210 This is just a straight-forward calculation. A. Compute cost of the 2006 household basket. ($9 x 5) + ($6 x 25) = $195 12

A C T I V E L E A R N I N G 2 Answers CPI basket: {10# beef, 20# chicken} Household basket in 2006: {5# beef, 25# chicken} beef chicken cost of CPI basket 2004 $4 $120 2005 $5 $150 2006 $9 $6 $210 Ask students which inflation rate (30% or 40%) they think more accurately measures the true increase in the cost of living for this example. Most students will correctly say “30%.” Ask them to explain their reasoning. You are guiding them to figure out substitution bias and why it’s a problem. B. Compute % increase in cost of household basket over 2005-6, compare to CPI inflation rate. Rate of increase: ($195 – $150)/$150 = 30% CPI inflation rate from previous problem = 40% 13

Problems with the CPI: Substitution Bias替代偏向 Over time, some prices rise faster than others. Consumers substitute toward goods that become relatively cheaper. The CPI misses this substitution because it uses a fixed basket of goods. Thus, the CPI overstates increases in the cost of living. 当价格年复一年地变动时，一些物品的价格上升得比另一些快一些 消费者用那些变得不太昂贵的物品来替代 CPI没有考虑这种替代，因为它使用了一篮子固定不变的物品 因此CPI高估了生活费用的增加 If you spent a few minutes of class time on the preceding exercise, you can go through this slide fairly quickly. MEASURING THE COST OF LIVING 14

Problems with the CPI: Introduction of New Goods新产品的引进 The introduction of new goods increases variety, allows consumers to find products that more closely meet their needs. In effect, dollars become more valuable. The CPI misses this effect because it uses a fixed basket of goods. Thus, the CPI overstates increases in the cost of living. 新产品的引进增加了产品的种类，允许消费者选择那些更满足他们需求的产品 从而每一美元变得更值钱 由于CPI使用的是一篮子固定的物品，它没有考虑到这种影响 因此CPI高估了生活费用的增加 MEASURING THE COST OF LIVING 15

Problems with the CPI: Unmeasured Quality Change无法衡量的质量变动 Improvements in the quality of goods in the basket increase the value of each dollar. The BLS tries to account for quality changes but probably misses some, as quality is hard to measure. Thus, the CPI overstates increases in the cost of living. 篮子中物品质量的提高增加了每一美元的价值 劳工统计局试图统计质量的变动，但还是漏掉了一些，因为质量是难以衡量的 因此CPI高估了生活费用的增加 MEASURING THE COST OF LIVING 16

Problems with the CPI Each of these problems causes the CPI to overstate cost of living increases. The BLS has made technical adjustments, but the CPI probably still overstates inflation by about 0.5 percent per year. This is important because Social Security payments and many contracts have COLAs tied to the CPI. 上述的这些问题都使CPI高估了生活费用的增加 劳工统计局已经进行了一些技术调整，但 CPI仍然可能每年高估了0.5%的通货膨胀 这很重要，因为社会保障补助以及许多合同都会根据CPI进行通货膨胀调整 In the 1990s, it was estimated that the CPI’s bias cost taxpayers $1 trillion every 12 years in unnecessary COLAs in Social Security and government pension payments!!! MEASURING THE COST OF LIVING 17

Two Measures of Inflation, 1950-2007 This figure shows the inflation rate – the percentage change in the level of prices – as measured by the GDP deflator and the Consumer Price Index using quarterly data from the U.S. economy. Notice that the two measures of inflation generally move together. There are a few years when they diverge a bit. The reasons for this are on the next slide. Sources: GDP deflator – Bureau of Economic Analysis, U.S. Dept of Commerce CPI – Bureau of Labor Statistics, U.S. Dept of Labor I obtained both from the Federal Reserve Bank of St. Louis “Fred” database: http://research.stlouisfed.org/fred2/ MEASURING THE COST OF LIVING 18

Contrasting the CPI and GDP Deflator Imported consumer goods进口消费物品: included in CPI excluded from GDP deflator Capital goods资本商品: excluded from CPI included in GDP deflator (if produced domestically) The basket: CPI uses fixed basket GDP deflator uses basket of currently produced goods & services This matters if different prices are changing by different amounts. 如果不同物品与劳务价格的变动量不同，我们对各种价格加权的方法对于整个通货膨胀率就是至关重要的 MEASURING THE COST OF LIVING 19

A C T I V E L E A R N I N G 3 CPI vs. GDP deflator In each scenario, determine the effects on the CPI and the GDP deflator. A. Starbucks raises the price of Frappuccinos. B. Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory. C. Armani raises the price of the Italian jeans it sells in the U.S. 在下列情况下，说出对CPI和GDP平减指数的影响 A. 星巴克提高了法布奇诺咖啡的价格 B. 卡特彼勒提高了它在伊利诺伊州工厂生产的工业拖拉机的价格 C. 亚曼尼提高了它在美国销售的意大利牛仔的价格 To make this exercise more challenging, move the preceding slide so that it appears immediately after the answers to this exercise. If you are outside the U.S., please make the following changes: In (b), change the example to “A local manufacturer raises the price on industrial tractors it produces.” In (c), change “U.S.” to your country’s name, unless your country is Italy. In that case, change the example to something involving an imported consumer good. 20

A C T I V E L E A R N I N G 3 Answers A. Starbucks raises the price of Frappuccinos. The CPI and GDP deflator both rise. B. Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory. The GDP deflator rises, the CPI does not. C. Armani raises the price of the Italian jeans it sells in the U.S. The CPI rises, the GDP deflator does not. A. 星巴克提高了法布奇诺咖啡的价格 CPI和GDP平减指数都上升了 B. 卡特彼勒提高了它在伊利诺伊 州工厂生产的工业拖拉机的价 格 GDP平减指数上升, CPI不变 C. 亚曼尼提高了它在美国销售的 意大利牛仔的价格 CPI上升，GDP平减指数不变 Explanations: A. Frappuccinos are produced in the U.S., so their prices are part of the GDP deflator. They are purchased by consumers, so their prices are part of the CPI. Hence, an increase in the price of Frappuccinos causes both the CPI and GDP deflator to increase. B. Since the tractors are produced here in the U.S., the price increase causes the GDP deflator to rise. However, industrial tractors are a capital good, not a consumer good, so the CPI is unaffected. C. Italian jeans appear in the U.S. consumer’s shopping basket, and hence the increase in their price causes the CPI to rise. However, the GDP deflator is unchanged because it only includes prices of domestically produced goods and excludes the prices of imports. 21

Correcting Variables for Inflation 根据通货膨胀的影响校正经济变量: Comparing Dollar Figures from Different Times比较不同时期的美元数字 Inflation makes it harder to compare dollar amounts from different times. Example: the minimum wage $1.15 in Dec 1964 $5.85 in Dec 2007 Did min wage have more purchasing power in Dec 1964 or Dec 2007? To compare, use CPI to convert 1964 figure into “today’s dollars”… 通货膨胀使比较不同时期的美元数字变得更加困难 例如：最低工资 在1964.12是$1.15 在2007.12是$5.85 最低工资在1964年12月还是在2007年12月有更强的购买力？ 为了方便比较，我们用CPI把1964年的数字转换为“今天的美元”…… MEASURING THE COST OF LIVING 22

Correcting Variables for Inflation: Comparing Dollar Figures from Different Times Amount in today’s dollars Amount in year T dollars Price level today Price level in year T = x In our example, year T = 12/1964, “today” = 12/2007 Min wage = $1.15 in year T CPI = 31.3 in year T, CPI = 211.7 today Note: the ratio of price levels = 211.7/31.3 = 6.76. This means that the cost of living has increased by a factor of 6.76. We multiply this factor by the 1964 figure to convert the latter into “today’s dollars.” Interpreting the result: The $1.15 minimum wage in December 1964 could have purchased $7.78 worth of goods and services if prices in 1964 equaled their December 2007 level. Source of data: Bureau of Labor Statistics, www.bls.gov The minimum wage in 1964 was $7.78 in today’s (2007) dollars. 211.7 31.3 $7.78 = $1.15 x MEASURING THE COST OF LIVING 23

Correcting Variables for Inflation: Comparing Dollar Figures from Different Times Researchers, business analysts and policymakers often use this technique to convert a time series of current-dollar (nominal) figures into constant-dollar (real) figures. They can then see how a variable has changed over time after correcting for inflation. Example: the minimum wage, from Jan 1950 to Dec 2007… 研究人员，商业分析师和政策制定者经常使用这种方法把一个时间序列的当期美元数字（名义）转换为不变美元（真实）数字 他们可以看到一个变量在根据通货膨胀的影响校正后是如何变化的 例如：最低工资，从1950年1月转换到2007年12月….. DISCLAIMER: The material on this slide is not supported with test bank or study guide questions. MEASURING THE COST OF LIVING 24

The U.S. Minimum Wage in Current Dollars and Today’s Dollars, 1950-2007 $9 2007 dollars $8 $7 $ per hour $6 $5 $4 DISCLAIMER: The material on this slide is not supported with test bank or study guide questions. Source: http://www.bls.gov $3 current dollars $2 $1 $0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

A C T I V E L E A R N I N G 4 Converting to “today’s dollars” Annual tuition and fees, average of all public four-year colleges & universities in the U.S. 1986-87: $1,414 (1986 CPI = 109.6) 2006-07: $5,834 (2006 CPI = 203.8) After adjusting for inflation, did students pay more for college in 1986 or in 2006? Convert the 1986 figure to 2006 dollars and compare. 美国普通的公立四年制学院与大学每年的教育费用： 1986-87: $1,414 (1986的CPI = 109.6) 2006-07: $5,834 (2006的CPI = 203.8) 经过通货膨胀校正，学生在哪一年会支付更多的费用，1986年还是2006年？将1986年的数字转化为 2006年的美元进行比较 Sources: Data on tuition and fees from Trends in College Pricing 2006, the College Board, www.collegeboard.com CPI from BLS.gov. 26

A C T I V E L E A R N I N G 4 Answers Annual tuition and fees, average of all public four-year colleges & universities in the U.S. 1986-87: $1,414 (1986 CPI = 109.6) 2006-07: $5,834 (2006 CPI = 203.8) Solution Convert 1986 figure into “today’s dollars” $1,414 x (203.8/109.6) = $2,629 Even after correcting for inflation, tuition and fees were much lower in 1986 than in 2006! 即使经过了通货膨胀校正，1986年的学费仍比2006年的学费低得多！ If prices were as high in 1986 as they were in 2006, then tuition & fees in 1986 would have been $2,629, less than half as much as actual tuition & fees in 2006! Tuition and fees have risen much faster than the overall cost of living. 27

Correcting Variables for Inflation: Indexation 根据通货膨胀的影响校正经济变量：指数化 A dollar amount is indexed for inflation if it is automatically corrected for inflation by law or in a contract. 某一美元根据法律或合同自动地按物价水平的变动校正时，这种美元量就称为通货膨胀的指数化 For example, the increase in the CPI automatically determines the COLA in many multi-year labor contracts许多长期劳动合同的COLA the adjustments in Social Security payments and federal income tax brackets社会保障补助和联邦所得税等级的调整 MEASURING THE COST OF LIVING 28

Correcting Variables for Inflation: Real vs Correcting Variables for Inflation: Real vs. Nominal Interest Rates 真实利率与名义利率 The nominal interest rate: the interest rate not corrected for inflation the rate of growth in the dollar value of a deposit or debt The real interest rate: corrected for inflation the rate of growth in the purchasing power of a deposit or debt Real interest rate = (nominal interest rate) – (inflation rate) 名义利率： 未根据通货膨胀的影响校正的利率 存款或债务的美元价值的增长率 真实利率: 根据通货膨胀的影响校正过的利率 存款或债务的实际购买力的增长率 真实利率 = (名义利率) – (通货膨胀率) MEASURING THE COST OF LIVING 29

Correcting Variables for Inflation: Real vs. Nominal Interest Rates Example: Deposit $1,000 for one year. Nominal interest rate is 9%. During that year, inflation is 3.5%. Real interest rate = Nominal interest rate – Inflation = 9.0% – 3.5% = 5.5% The purchasing power of the $1000 deposit has grown 5.5%. MEASURING THE COST OF LIVING 31 30

Real and Nominal Interest Rates in the U.S., 1950-2007 This graph replicates Figure 3 from this chapter. The figure is constructed using quarterly data from the U.S. The nominal interest rate is the rate on a three-month Treasury Bill. The real interest rate is the same, minus the inflation rate as measured by the percentage change in the CPI. Notice that the nominal and real interest rates often do not move together, indicating that the real interest rate varies over time. Sources: CPI – Bureau of Labor Statistics Treasury bill rate – Board of Governors of the Federal Reserve System. I obtained both from the Federal Reserve Bank of St. Louis “Fred” database: http://research.stlouisfed.org/fred2/ MEASURING THE COST OF LIVING 31

CHAPTER SUMMARY 消费物价指数是生活费用的一种衡量指标，衡量普通消费者购买的一篮子物品与服务的费用 The Consumer Price Index is a measure of the cost of living. The CPI tracks the cost of the typical consumer’s “basket” of goods & services. The CPI is used to make Cost of Living Adjustments and to correct economic variables for the effects of inflation. The real interest rate is corrected for inflation and is computed by subtracting the inflation rate from the nominal interest rate. 消费物价指数是生活费用的一种衡量指标，衡量普通消费者购买的一篮子物品与服务的费用 用CPI来进行生活费用调整和校正通货膨胀影响的经济变量 真实利率是经过通货膨胀校正的利率，等于名义利率减去通货膨胀率 32