# Measuring The Cost of living

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Information about Measuring The Cost of living

Published on September 28, 2015

Author: djalex035

Source: slideshare.net

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%

10. Inflation ??

11. 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

12. 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)

13. 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.

14. 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

15. 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.

16. 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)

17. 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 )

18. 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)

19. 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.

20. 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.

21. 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.

22. 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

23. 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

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

25. 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.

26. 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

27. 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)

28. 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)

29. 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

30. 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%

31. 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?

32. 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.

33. 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

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