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Lecture Economics: Chapter 25 - Dean Karlan, Jonathan Morduch

Chapter 25 - The cost of living. After studying this chapter you will be able to understand: What a market basket is and why it’s important? How to calculate and use a price index? How to identify challenges the Bureau of Labor Statistics (BLS) faces when measuring inflation? How the BLS responds to these challenges?. | Chapter 25 The Cost of Living © 2014 by McGraw-Hill Education 1 What will you learn in this chapter? • What a market basket is and why it’s important. • How to calculate and use a price index. • How to identify challenges the Bureau of Labor Statistics (BLS) faces when measuring inflation. • How the BLS responds to these challenges. • How to calculate the inflation rate using three methods. • How to adjust nominal values into real values. • How to define and calculate purchasing power parity. © 2014 by McGraw-Hill Education 2 The cost of living • A large focus of macroeconomics is prices, but more importantly how changes in prices impact how much we can buy. • Prices change at different speeds across time and place. • Changing prices have effects on people’s incentives and choices. – Price levels determine the relative value of salaries, savings and borrowing, and the relative cost of living in a different city. © 2014 by McGraw-Hill Education 3 1 The market basket • The prices of many different goods and services must be considered when comparing the cost of living across time and place. • The market basket is a list of specific goods and services in fixed quantities. – The goal is to use this to see how the cost of buying these goods and services changes over time and location. – Items typically purchased by individuals. – Keeping the quantities of each item constant ensures that changes only reflect price changes. © 2014 by McGraw-Hill Education 4 The market basket • Consider changes in the prices of four items you typically buy at the grocery store. • How much did the cost of groceries rise between years? Quantity purchased Price last year ($) Price this year ($) Bread (per loaf) 1 3.00 3.15 Milk (per gallon) 1 2.50 2.55 Beef (per pound) 3 3.50 3.64 Carrots (per pound) 1 1.00 1.25 Total Cost2012 = ($3.00 x 1)+($2.50 x 1)+($3.50 x 3)+($1.00 x 1)= $17.00 Total Cost2013 = ($3.15 x 1)+($2.55 x 1)+($3.64 x 3)+($1.25 x 1) = $17.87 Price