1. Agenda: Current Events Presentation? Finish GDP graphs GDP practice activity Begin CPI, if time permits

2. Consumer Price Index CPI is a market basket price index based on hundreds of items Government’s “most important” statistic Announced monthly by Bureau of Labor Statistics Measures changes in prices of goods and services over time Allows us to convert amounts into dollars of same year

3. Consumer Price Index Why do track this data? - As an economic indicator. - As a deflator of other economic series. - As a means of adjusting dollar values.

4. The CPI represents the purchases of people living in urban areas (covers about 80% of U.S. population) The market basket (goods and services) is determined by the Consumer Expenditure Survey of 29,000 households (they use random sampling) Prices are also determined by surveys (80,000 prices in 85 cities at a representative sample of stores)

5. Limitations of the CPI The CPI is subject to both limitations in application and limitations in measurement: Limitations of application: The CPI may not be applicable to all population groups. For example, the CPI-U is designed to measure inflation for the U.S. urban population and thus may not accurately reflect the experience of people living in rural areas. Also, the CPI does not produce official estimates for the rate of inflation experienced by subgroups of the population, such as the elderly or the poor. The CPI cannot be used to measure differences in price levels or living costs between one place and another; it measures only time-to-time changes in each place. A higher index for one area does not necessarily mean that prices are higher there than in another area with a lower index. It merely means that prices have risen faster in the area with the higher index since the two areas' common reference period. The CPI cannot be used as a measure of total change in living costs because changes in these costs are affected by (such as social and environmental changes and changes in income taxes) that are beyond the definitional scope of the index and so are excluded. Limitations in measurement: Limitations in measurement can be grouped into two basic types, sampling errors and non-sampling errors. Sampling errors. Because the CPI measures price changes based on a sample of items, the published indexes differ somewhat from what the results would be if actual records of all retail purchases by everyone in the index population could be used to compile the index. These estimating or sampling errors are limitations on the accuracy of the index, not mistakes in calculating the index. The CPI program has developed measurements of sampling error, which are updated and published annually on the CPI home page. The CPI sample design allocates the sample in a way that maximizes the accuracy of the index, given the funds available. Non sampling errors. These errors occur from a variety of sources. Unlike sampling errors, they can cause persistent bias in measurements of the index. Nonsampling errors are caused by problems of price data collection, logistical lags in conducting surveys, difficulties in defining basic concepts and their operational implementation, and difficulties in handling the problems of quality change. Nonsampling errors can be far more hazardous to the accuracy of a price index than sampling errors. Hence, BLS expends much effort to minimize these errors. Highly trained personnel ensure the comparability of quality of items from period to period (see answer to question 8); collection procedures are extensively documented, and recurring audits are conducted. The CPI program has an ongoing research and evaluation program in order to identify and implement improvements in the index.(see answer to question 8)

6. 12/12/13 Agenda: Finish CPI, practice with equations

7. 2010

8. Index Number Measures price relative to base period Gives us a nominally-based value (not adjusted for inflation, merely raw dollars) University of Washington Tuition & Fees: ( $12,397/$2907) x 100 = UW tuition index number for 2013-14 with 1994-95 as the base period: 426.45% Result: Tuition has increased 426% since 1994.

9. Good/service1980 quantity1980 price1980 cost Pizza100$7 each$700 Textbooks20$40 each$800 Haircuts5$5 each$25 Total cost$1,525 Good/service1980 quantity2000 price2000 cost Pizza100$13 each$1,300 Textbooks20$75 each$1,500 Haircuts5$10 each$50 Total cost$2,850

10. Student Price Index Compare cost of the same collection of goods and services over time Comparing same goods and services: Cost $1,525 in 1980, but… Cost $2,850 in 2000. Student Price Index is: (2850/1525) x 100 = 186.89

11. The 20 th century was time of inflation---prices rose throughout the century increasing rapidly after 1973. Historical Trends

12. Affects elections, economy, government policies, Social Security, pensions Bureau of Labor Statistics: “Directly affects incomes of over 80 million people” Political Implications

13. Adjusting for changes in buying power “Constant dollars,” “real income” means dollars represent same buying power even though they may describe different years Basic Conversion Formula: To convert an amount in dollars at time A to the amount with the same buying power at time B:

14. Example: University of Washington’s Tuition in 2012 Dollars 1994: $2907 vs. 2013: $12,397 (What is 1994’s $2907 tuition equivalent to today, in 2012 dollars?) Tuition rose nominally from $2907 to $12,397… So, nominal tuition rose (12,397/2907)/2907= 3.26 = 326% But the comparison should be made in constant dollars: Let’s use 2012 dollars: = 1994 dollars * (2012 CPI/1994 CPI) = $2907 * (229.6/148.2) = $4503.7 So, $2907 1994 dollars = $4503.70 2012 dollars In constant 2012 dollars, tuition rose from $4503.70 to $12,397. (Ouch) Tuition rose in real terms by (12397-4503)/4503 = 1.75 = 175%

15. Example – Pizza 1962: The price of a slice of pizza in Boston’s Park Street subway station was 25¢ In today’s prices that’s: (.25¢) * (224.939 /30.2) = 186.21¢ = $1.86 A pizza slice that’s $2.50 today rose (2.50-.25)/.25 = 9 = 900% (10 fold) in nominal terms. The price has increased (2.50-1.86)/1.86 = 0.34 = 34% in real dollars

16. Exercise: The Minimum Wage Restate the minimum wage in 1970 dollars Make two line graphs on the same axes, showing the actual wage and the real wage in constant 1970 $$ Explain what your graph shows about the history of the minimum wage How much has the minimum wage increased since 1970, both nominally and in real terms? YearMinimum Wage 1960$1.00 1965$1.25 1970$1.60 1975$2.10 1980$3.10 1985$3.35 1990$3.80 1995$4.25 2000 2005 2010 $5.15 $7.25

17. 1991134.6134.8135.0135.2135.6136.0136.2136.6137.2137.4137.8137.9136.23.14.2 1992138.1138.6139.3139.5139.7140.2140.5140.9141.3141.8142.0141.9140.32.93.0 1993142.6143.1143.6144.0144.2144.4 144.8145.1145.7145.8 144.52.73.0 1994146.2146.7147.2147.4147.5148.0148.4149.0149.4149.5149.7 148.22.72.6 1995150.3150.9151.4151.9152.2152.5 152.9153.2153.7153.6153.5152.42.52.8 1996154.4154.9155.7156.3156.6156.7157.0157.3157.8158.3158.6 156.93.33.0 1997159.1159.6160.0160.2160.1160.3160.5160.8161.2161.6161.5161.3160.51.72.3 1998161.6161.9162.2162.5162.8163.0163.2163.4163.6164.0 163.9163.01.6 1999164.3164.5165.0166.2 166.7167.1167.9168.2168.3 166.62.72.2 2000168.8169.8171.2171.3171.5172.4172.8 173.7174.0174.1174.0172.23.4 2001175.1175.8176.2176.9177.7178.0177.5 178.3177.7177.4176.7177.11.62.8 2002177.1177.8178.8179.8 179.9180.1180.7181.0181.3 180.9179.92.41.6 2003181.7183.1184.2183.8183.5183.7183.9184.6185.2185.0184.5184.3184.01.92.3 2004185.2186.2187.4188.0189.1189.7189.4189.5189.9190.9191.0190.3188.93.32.7 2005190.7191.8193.3194.6194.4194.5195.4196.4198.8199.2197.6196.8195.33.4 2006198.3198.7199.8201.5202.5202.9203.5203.9202.9201.8201.5201.8201.62.53.2 2007202.4203.5205.4206.7207.9208.4208.3207.9208.5208.9210.2210.0207.34.12.8 2008211.1211.7213.5214.8216.6218.8219.964219.086218.783216.573212.425210.228215.3030.13.8 2009211.143212.193212.709213.240213.856215.693215.351215.834215.969216.177216.330215.949214.5372.7-0.4 2010216.687216.741;217.631218.009218.178217.965218.011218.312218.439218.711218.803219.179218.0561.51.6 2011220.223221.309;223.467224.906225.964225.722225.922226.545226.889226.421226.230225.672224.9393.03.2 2012226.655227.663229.392230.085229.815229.478229.104230.379231.407231.317230.221229.601229.5941.72.1 2013230.280232.166232.773232.531232.945233.504233.596233.877234.149233.546

19. Minimum wage

20. CPI: A closer look Who is covered? – CPI market basket represents purchases of people living in urban areas – About 80% of U.S. population covered How is market basket chosen? – By sampling! – Data from 29,000 households – Basket items are weighted

21. CPI controversies Does a “fixed basket” approach overstate inflation? If beef prices go up and rice prices stay the same, people will eat more rice? Should market basket reflect these changes in consumption? Or should index account for this decline in standard of living?

22. CPI controversy Old method – Last year I bought 1 head of iceberg and 1 head of romaine lettuce at $1.00 each, spending $2.00 total – Now price of romaine rises to $1.50 a head – I now spend $1.00 + $1.50 = $2.50, 25% increase New method – Since romaine went up I’ll reduce how much romaine I buy but keep spending the same amount for each – I now buy 1.225 heads of iceberg and.816 heads of romaine spending the same on each, since 1.225 x ($1) =.816 x ($1.50). – Now I’ve spent $1.225 + $1.225 = $2.45, 22.5% increase

23. CPI and government statistics What it is: CPI measures prices of goods and services over time What it is not: Doesn’t measure changes to standard of living CPI and government statistics need to be free from political influence to be accurate and timely Canada has a single statistical office (see www.statcan.ca); ranked first among government statistical agencies www.statcan.ca U.S. has 72 federal statistical offices