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Consumer Price Index
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Nominal vs. Real Prices (or wages)
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Nominal price: list or actual cost given current value of money
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Nominal price: Useful for comparisons within same time period and in same location
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Problem with nominal prices: Cannot make meaningful comparisons of prices across time periods or locations.
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Prices of products in 1962: $0.05 for a Hershey bar
$0.05 for a copy of New York Times $0.04 for first class postage stamp $0.31 for gallon of regular gas $0.28 for McDonalds double hamburger $2, for full-size Chevrolet
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Why can’t one compare 1962 prices with prices for same or similar products today? More precisely, why are such comparisons meaningless?
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Real price: Cost relative to general economic conditions in a place and time.
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A B C DePaul tuition 20,000 Vacation 5,000 2,000 Corvette 50,000 95,000 25,000 Concert tickets 200 2000 50 Apartment 18,000 900
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DePaul tuition is more in column C than in column A or B and is less in column B than in column A
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Why?
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Why? Because the price of an item only has meaning in terms of what one passes up to buy it.
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Similarly with wages: Income only can be evaluated in terms of what can be purchased with it.
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Inflation: A general rise in prices in an economy.
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Deflation: A general decrease in prices in an economy.
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Inflation and deflation create disparities between real and nominal prices.
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Suppose a young person gets an allowance of $10 per week
Suppose a young person gets an allowance of $10 per week. Her allowance allows her a certain level of consumption.
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Suppose that the prices of goods she normally buys increase by 20% and her father increases her allowance to $11.
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Has her allowance increased?
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Answer: Her nominal allowance has increased but her real allowance has decreased.
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