Economics

Shortcomings in the CPI as a Measure of the Cost of Living

• A core inflation index is typically calculated by taking the CPI and excluding volatile economic variables.
• The cost of living represents how much it costs for a person to feel that his or her consumption provides an equal level of satisfaction or utility.
• Substitution bias tends to overstate the rise in a consumer’s true cost of living.
• The CPI tends to understate consumers’ standard of living, as measured by nominal income/CPI.

The GDP Deflator and Other Major Price Indices

• Employment Cost Index: estimate of the average cost of labor compensation to employers, including wages, salaries and fringe benefits.
• GDP Deflator: price index which measures the average price of all goods and services included in GDP; used to convert nominal into real GDP.
• Producer Price Index: price index based on prices paid for supplies and inputs by producers of goods and services.

The GDP Deflator and Producer Price Index

• The GDP Deflator goes by several names, such as the Implicit Price Deflator for GDP, and the GDP Price Index, but they all mean the price index which is used to convert nominal into real GDP.
• Producer Price Index can be broken down into price indices for different industries, commodities, and stages of processing (like finished goods, intermediate goods, crude materials for further processing, and so on)

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Problems with Inflation

• 401(k): a defined contribution retirement program to which the employee and often the employer contribute
• Nominal Interest Rate: the actual interest rate charged on a loan
• Pension: a defined benefit retirement payment
• Real Interest Rate: the interest rate after inflation is taken into account; the nominal interest rate minus the rate of inflation