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lculated as follows: C P I i n Y e a r 2 C P I i n Y e a r 1I n f l a t i o n R a t e i n Y e a r 2 = 1 0 0C P I i n Y e a r 1? ?169。 2022 Thomson SouthWestern Table 1 Calculating the Consumer Price Index and the Inflation Rate: An Example 169。 2022 Thomson SouthWestern 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 munication 169。 2022 Thomson SouthWestern Problems in Measuring the Cost of Living ? Substitution Bias ? The basket does not change to reflect consumer reaction to changes in relative prices. ? Consumers substitute toward goods that have bee relatively less expensive. ? The index overstates the increase in cost of living by not considering consumer substitution. 169。 2022 Thomson SouthWestern Problems in Measuring the Cost of Living ? Unmeasured Quality Changes ? If the quality of a good rises from one year to the next, the value of a dollar rises, even if the price of the good stays the same. ? If the quality of a good falls from one year to the next, the value of a dollar falls, even if the price of the good stays the same. ? The BLS tries to adjust the price for constant quality, but such differences are hard to measure. 169。 2022 Thomson SouthWestern The GDP Deflator versus the Consumer Price Index ? The GDP deflator is calculated as follows: G D P d e f l a t or = N o m i n a l G D PR e a l G D P ? 100169。 2022 Thomson SouthWestern The GDP Deflator versus the Consumer Price Index ? Economists and policymakers monitor both the GDP deflator and the consumer price index to gauge how quickly prices are rising. ? There are two important differences between the indexes that can cause them to diverge. 169。 2022 Thomson SouthWestern The GDP Deflator versus the Consumer Price Index ? The consumer price index pares the price of a fixed basket of goods and services to the price