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Measuring the Cost of Living
• Consumer Price Index (CPI）：
消費者物價指數
• shows the cost of a basket of goods and
services bought by a typical family relative to
the cost of the same basket in the base year.
‧used to monitor changes in the cost of living
over time. When the CPI rises, the typical
family has to spend more dollars to maintain
the same standard of living.
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FYI: What Is in the CPI’s Basket?
17%
Transportation
15%
Food and
beverages
Medical care
6%
Recreation
6%
Apparel
4%
Other goods
and services
4%
42%
Housing
6%Education and
communication
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How to calculate CPI
• The CPI is calculated as follows:
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Inflation Rate
• The Inflation Rate（π）：
通貨膨脹率＝物價上漲率
• When π<0：deflation (通貨緊縮)
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Table Calculating CPI & Inflation Rate:
An Example
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Table Calculating CPI & Inflation Rate:
An Example
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Problems in Measuring the Cost of Living
• CPI：not a perfect measure of cost of living：
(1) Substitution bias
(2) Introduction of new goods
(3) Unmeasured quality changes
• cause the CPI to overstate the true cost of
living.
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Ch23: The GDP Deflator
• The GDP deflator is calculated as follows:
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The GDP Deflator vs. CPI
• Economists and policymakers monitor both the
GDP deflator and CPI to gauge how quickly
prices are rising.
• two important differences to diverge:
• produced domestically vs. bought by consumers
• currently produced vs. a fixed basket
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Taiwan: 2 measures of inflation
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Taiwan data：π
Inflation rate
% (GDP deflator)
Inflation rate
%(CPI)
1961-2007
1961-1970
1971-1980
1981-1990
1991-2000
2001-2007
1974 π=%
1980 π=%
1981 π=%
2001-2003 π<0
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Other Price Index
• The index for different regions/sectors within
the country.
• The Producer Price Index
（生產者物價指數）, which measures the
cost of a basket of goods and services bought
by firms rather than consumers.
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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.
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Dollar Figures from Different Times
• To convert (inflate) Ruth’s wages in 1931 to
dollars in 2001:
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Indexation（指數化）
• When some dollar amount is automatically
corrected for inflation by law or contract, the
amount is said to be indexed for inflation.
• Indexation for wage
• Indexation for interest rate
• 機動調整
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Real and Nominal Interest Rates
• Interest represents a payment in the future for a
transfer of money in the past.
• Nominal interest rate （R，名目利率）:
the interest rate usually reported.
• It is the interest rate that a bank pays.
• Real interest rate （r，實質利率）:
nominal interest rate corrected for the effects of
inflation.
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Real and Nominal Interest Rates
• You lend out $100 for one year. P=$1/candy
• Nominal interest rate was 10%.
• During the year inflation was 6%.
• Present $100/$1= 100 units of candies
• $100*(1+10%)/[$1*(1+6%)]= units of candies
• Real return= units, real rate of return= %
• Real interest rate （real rate of return）
近似= Nominal interest rate – Inflation rate
= 10% - 6% = 4% ( r=R-π)
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Taiwan: R and π
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Taiwan data：π and R
Inflation rate % (CPI) Nominal R %
1961-2006
1961-1970
1971-1980
1981-1990
1991-2000
2001-2006
1974
1980
1981
2001-2006 (-) 零利率年代
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Taiwan data: r
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R , r, and expectation
• r =R-π
So r <0 if R<π
r >R if π<0
• 契約訂定名目利率
R= re + πe (e: expected，預期的)
→ 實現的（realized）或實際的(actual)
r =R-π＝ re + πe -π，
So r < re if πe <π
r = re if πe=π
r > re if πe >π
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Ch 24: Summary
• How to calculate CPI?
• How to calculate Inflation rate?
• CPI vs. GDP deflator
• Nominal interest rate vs. real interest rate
• 實際的 actual r =R-π，
• R= re + πe (e: expected，預期的)
• Possible r < 0?
• Possible r > R?
