MACRO ECONOMICS Power point Slides

1. MEASURING THE COST OF LIVING

2. Overview
Learn how the Consumer Price Index (CPI) is
constructed.
Calculating Consumer Price Index and the Inflation
Rate.
Problems in measuring the cost of living.
Correcting economic variables for the effects of
inflation.

3. Measuring the Cost of Living
In determining the cost of living, Statistics BD first
identifies a “market basket” of goods and services the
typical consumer buys.
Annually, Statistics BD surveys consumers to
determine what they buy and the overall cost of the
goods and services they buy.

4. Measuring the Cost of Living
The Consumer Price Index (CPI) is used to
monitor changes in the cost of living (i.e. the
selected market basket) over time. When the
CPI rises, the typical family has to spend more
dollars to maintain the same standard of living.
The goal of the CPI is to measure changes in
the cost of living. It reports the movement of
prices not in dollar amounts, but with an index
number.

5. What’s in the CPI’s Basket?
Shelter
27.9%
Transportation
18.3%
% of CPI, Food, 18,
18.0%
Recreation
10.4%
% of CPI,
Household, 10,
10.0%
Clothing
6.6%
Education
4.5% Health
4.3%

6. What is an Index Number?
An Index Number is developed
with an arbitrary base (usually
starting with 100) that indicates
a change in magnitude relative to
its value at a specified point in
time.

7. Overview
 Learn how the Consumer Price Index (CPI) is
constructed.
Calculating Consumer Price Index and the Inflation
Rate.
Problems in measuring the cost of living.
Correcting economic variables for the effects of
inflation.

8. Calculating the Consumer Price Index and the
Inflation Rate
Determine what goods are most important to
the typical consumer: Fix the Basket
Find the prices of each of the goods and
services in the basket for each point in time:
Find the Prices
Use the data on prices to calculate the cost of
the basket of goods and services at different
times: Compute the Basket’s Cost
Designate one year as the Base Year, which is
the benchmark for yearly comparison.

9. Calculating the Consumer Price Index and
the Inflation Rate
The final step includes using the CPI to
calculate the Inflation Rate, which is:
 the percentage change in the price index from the preceding period
Example:
 Base Year is 2000
 Bundle of goods in 2000 = $1,200
 The same bundle in 2002 cost = $1,272
 CPI = ($1,272 ÷ $1,200) X 100 = 106
 Prices between 2000 & 2001 increased 6%

11. Inflation ??

12. Inflation
 Inflation rate : The percentage change in the price
index from the preceding period.
 Two types of Inflation rate in Bangladesh :Food
Inflation & non-food Inflation
 Inflation rate in Year 2=CPI in Year 2-CPI in Year 1 × 100
CPI in Year 1
Inflation 2013-14
Food-Inflation 8.56
Non-Food Inflation 5.55
General 7.35
Table 1 (Source: Bangladesh Bureau of Statistics, 2014). Also see :Figure 3 for CPI data

13. Other Price Indexes
Other Price Indexes are computed for:
Specific regions within the country
(e.g. each District and for 6 cities
across Bangladesh)
Narrow categories of goods and
services (e.g. food, clothing, etc.)
Producer costs of resources (i.e.
industrial product price index)

14. Overview
 Learn how the Consumer Price Index (CPI) is
constructed.
 Calculating Consumer Price Index and the Inflation
Rate.
Problems in measuring the cost of living.
Correcting economic variables for the effects of
inflation.

15. Problems in Measuring The Cost of Living
The CPI is an accurate measure of the selected
goods that make up the “typical bundle,” but it
is not a perfect measure of the “cost of living.”
Three reasons/problems:
Substitution Bias
Introduction of new goods
Unmeasured quality change

16. CPI for Bangladesh
 Bangladesh Bureau of Statistics (BBS) computes National
Consumer Price Index (CPI)using food and non-food
commodities basket and services consumed by the
consumers in their day-to-day life.
 In order to construct the price index, the commodity and
weight of the index basket from the Household Income and
Expenditure Survey (HIES) 2005-06 is used. All rural and
urban price indices were compiled using the lists of
consumer goods of rural and urban households based on
the survey.
 And finally, the national price index is computed by taking
into account the weighted average of consumption
expenditures of the two areas.

17. Share of Components of consumption
Expenditure (for Bangladesh)
Series1,
Food &
Beverag
e,
53.81,
54%
Series1,
Cloth &
Footwe
ar, 5.51,
6%
Series1,
Housin
g and
House
Rent ,
12.25,
12%
Series1,
Fuel
and
Lightin
g , 5.98,
6%
Series1,
Househ
old
Effects ,
2.05,
2%
Series1,
Miscell
aneous
, 20.37,
20%
2005
Series1, Food &
Beverage,
54.81, 55%
Series1, Cloth
& Footwear,
4.95, 5%
Series1,
Housing and
House Rent ,
9.95, 10%
Series1,
Fuel and
Lighting ,
5.63, 5%
Series1,
Household
Effects , 1.68,
2%
Series1,
Miscellaneous ,
22.98, 23%
Food & Beverage Cloth & Footwear
Housing and House Rent Fuel and Lighting
Household Effects Miscellaneous
2010
Figure 1 (Source: Household Income and Expenditure Survey, 2010)

18. Percentage Share of Food Expenditure
Year 2010 2005
Total Food Expenditure (in Tk.) 6031 3209
% of Total 100 100
Cereals 35.95 39
Pulses 2.35 2.65
Fish 13.71 12.24
Meat & eggs 10.31 8.51
Vegetables 7.79 8.38
Milk/Milk Products 3.02 3.74
Edible oil 4.35 4.25
Condim/Spices 9.99 7.52
Fruits 4.08 3.23
Sugar/Gur 1.06 1.56
Beverage 0.73 0.68
Miscellanies 5.67 8.25
Figure 2(Source: Chapter 4, HIES(Household Income and Expenditure Survey) 2010,Bangladesh Bureau of
Statistics )

19. Inflation Rate ,
2007-08, 12.3
Inflation Rate ,
2008-09, 7.6
Inflation Rate ,
2009-10, 6.82
Inflation Rate ,
2010-11, 10.91
Inflation Rate ,
2011-12, 8.69
Inflation Rate ,
2012-13, 6.78
Inflation Rate ,
2013-14, 7.35
CPI, 2007-08,
122.84
CPI, 2008-09,
132.17
CPI, 2009-10,
141.18
CPI, 2010-11, 156.59
CPI, 2011-12, 170.19
CPI, 2012-13, 181.73
CPI, 2013-14,
195.08
Inflation Rate CPI
Consumer Price Index and Inflation (Base Year 2005-06)
Figure 3(Source: Bangladesh Economic Review, 2014)

20. Problems of CPI: Substitution Bias
The bundle does not change in the short run to reflect
consumer reaction to changing relative prices.
 Consumers substitute toward goods that have become
relatively less expensive.
 CPI is computed assuming a fixed basket of goods.
 The index overstates the increase in cost of living by not
considering the substitution by the consumer.

21. Problems of CPI: New Goods
The bundle does not reflect the effects of new products
that typically go down in price after introduction.
 New products result in greater variety, which in turn makes
each dollar more valuable. Consumers need fewer dollars to
maintain any given standard of living.
 The CPI is based on a fixed basket of goods and does not
reflect the change in the purchasing power of the dollar.

22. Problems of CPI: Quality Changes
Higher market prices usually include quality changes
that do not necessarily represent a higher cost of living.
 If the quality of a good decreases from one year to the next,
the value of a dollar falls, even if the price of the good stays
the same.
 The true cost of living may be less even though some goods
cost more.

23. Problems of CPI
 The substitution bias, introduction of new goods, and
unmeasured quality changes cause the CPI to overstate
the true cost of living.
 The issue is important because many government programs
use the CPI to adjust for changes in the overall level of prices.
 The CPI overstates inflation by about 1 percentage point per
year

24. The Consumer Price Index
versus the GDP Deflator
 GDP deflator & CPI give some what different information
about what’s happening to the overall level of prices in the
economy.
 Three Key Differences:
1. GDP deflator measures the prices of all goods and services
produced
whereas CPI measures the prices of only the goods and services
bought by consumers
2. GDP deflator includes only those goods produced domestically.
Imported goods are not a part of GDP and do not show up in the
GDP deflator. On the other hand, CPI include imported goods.
3. CPI is computed using a fixed basket of goods whereas
GDP deflator allows the basket of goods to change over time as the
composition of

25. Quick Quiz!
Explain briefly what the
consumer price index is
trying to measure and
how it is constructed.

26. Overview
 Learn how the Consumer Price Index (CPI) is
constructed.
 Calculating Consumer Price Index and the Inflation
Rate.
 Problems in measuring the cost of living.
Correcting economic variables for the effects of
inflation.

27. Correcting Economic Variables for the Effects of
Inflation
Price indexes are used to correct for the effects of
inflation when comparing dollar figures from different
times.
When some dollar amount is automatically corrected for
inflation by law or contract the amount is said to be
indexed for inflation.
 e.g., Real Interest Rate , Inflation adjusted Pension

28. Correcting Economic Variables for the Effects of
Inflation
To convert (inflate) past wages and prices into
current terms:
Current Year Dollars =
Past Year Nominal Value X [(Price index in current
year) ÷ (Price index in past year)]
Or
Amount in today’s Taka= Amount in Year ‘T’ Taka×
(Price Level today × Price level in Year T)

29. Correcting Economic Variables for the Effects of
Inflation
To convert (deflate) current wages and prices into
past year terms:
Value in Past Year Dollars =
Current Year Value X [(Price index in past year) ÷
(Price index in current year)]
Example: Salary in 1931 = Salary in 2015 X [(Price
index in 1931) ÷(Price index in 2015)]
›80,000 tk = 1,026316 tk X (15.2÷195)

30. Real and Nominal Interest Rates
Interest represents a payment in the future for a transfer
of money in the past.
Nominal interest rate:
 The rate that the bank pays in current value.
Real interest rate:
 The interest rate corrected for inflation.
 Real interest rate = Nominal - Inflation

31. Real and Nominal Interest Rates
Example — Assume:
 You borrow $1,000 for one year.
 Nominal Interest rate was 15%.
 During the year inflation was 10%.
The real interest rate is:
15% - 10% = 5%

32. Conclusion
When comparing dollar values from different times, it is
necessary to keep in mind that a Taka today is not the same as
a Taka in the past.
The CPI illustrates one way that prices are measured and how
to make adjustments for these price changes.
One Tk Value at the Time of Shah-e-sta Khan compared to
Today?

33. Overview
 Learn how the Consumer Price Index (CPI) is
constructed.
 Calculating Consumer Price Index and the Inflation
Rate.
 Problems in measuring the cost of living.
 Correcting economic variables for the effects of
inflation.

34. Effects of Inflations
Consumers Producers Economy
Zero
inflation
Not affected at
all
No incentive to
produce more,
Same production
Stagnant for
almost same
level of
production
Mild
Inflation
Affected but
not much,
Demand may
be same
Have incentive to
produce more,
Higher production
Economy
expands as
production
increase
High
Inflation
Affected much,
Demand may
be lower in
many products
Producers of
inelastic products
affected,
Production lower for
lower demand
Economy
squeezes as
production
falls