MACROECONOMICS BBA ECO 103

INFLATION, CPI, COST OF LIVING

FACULTY: Dr. Firdaus Khan, SP Jain School of Global Management, Mumbai Campus

INSTRUCTION:

Watch the video on the link: hCps://www.youtube.com/watch?v=F0VaaZdH1x0

What Is Inflation?

If you're like most people, you probably find yourself wondering "why doesn't my money go as far as
it used to?" In fact, it's very common to find yourself feeling like you aren't able to purchase as many
"things" as you were once able to. This is due to. InflaUon and its impact on our purchasing power.

InflaUon is defined as a sustained increase in the general level of prices for goods and services. It is
measured by the Consumer Price Index (CPI) as an annual percentage increase in prices compared to
a fixed or a base year. InflaUon (conUnued price rise in most goods and services) causes the purchasing
power of money to fall. If leX unchecked, inflaUon can lower people’s standard of living and cause
social unrest. Hence, prices are closely watched and CPI is reported on a monthly basis by the
the Bureau of Labor StaUsUcs (BLS) in the United States and by the RBI in India. It is important to
remember that prices can go up (inflaUon) or go down (deflaUon).

What is Consumer Price Index?

Ask the common person what is inflaUon, the answer is "it's when prices go up." But, which prices?
In order to tackle the idea of how far someone's money goes, and how quickly prices are increasing,
or decreasing, economists use the noUon of "baskets." Now these are not real, physical baskets, but
rather hypotheUcal and imaginary baskets of goods and services. Since trying to measure the price of
every good and every service available to all people across various segments, and at all Umes, is
virtually impossible, economists idenUfy a representaUve "basket" of goods and services that many
people generally purchase. This way Consumer Price Index (CPI) calculaUon is done on a typical market
basket that can be an effecUve indicator of how prices for all goods and services in that segment are
changing over Ume. This is done by comparing the cost of the market basket in a given year to the cost
of the market basket in the base year, or the year we're trying to compare changes to.

CPI measures the monthly change in prices of a market basket or a bundle of goods and services
commonly purchased by a segment of the populaUon. This way, it enables tracking and measuring
changes in an economy's price level, as well as the cost of living that people in those segments face.

The Bureau of Labour Studies (BLS) publishes two indexes each month - Consumer Price Index for All
Urban Consumers or CPI-U (which represents 93% of the U.S. populaUon not living in remote rural
areas) and Consumer Price Index for Urban Wage Earners and Clerical Workers or CPI-W (which covers
29% of the U.S. populaUon living in households with income derived predominantly from clerical
employment or jobs with an hourly wage). Since wage earners are more at risk to meet their daily
needs in the face of conUnuously rising price line, the BLS uses CPI-W to adjust Social Security
payments as well as other federal benefits and pensions for changes in the cost of living. This how
inflaUon and CPI link to cost of living. (Note that Wholesale Price Index - WPI or Producer Price Index
– PPI is used for tracking of prices for a basket of commodiUes from producers’ perspecUve)

What is Cost of Living?

The cost of living is the amount of money needed to cover basic expenses such as housing, food, taxes,
and healthcare in a certain place and Ume period. The cost of living is oXen used to compare how
expensive it is to live in one city versus another. The cost of living is Ued to wages. If expenses are
higher in a city, such as New York, for example, salary levels must be higher so that people can afford
to live in that city. Cost of living closesly associates with one’s lifestyle and one’s ability to accumulate
wealth. The cost of living can be a significant factor in personal wealth accumulaUon because a salary
can provide a higher standard of living in a city where daily expenses such as rent, food and
entertainment are less. In contrast, a high salary can seem insufficient in an expensive city such as New
York. It is used as benchmark for workforce entrants or relocaUon by currently employed job seekers.
The index provides an informaUve snapshot of rental, transportaUon and grocery costs. Another
usefulness of cost of living index is the advocacy of minimum wage.

The cost of living index is a comparaUve measure that aggregates various living expenses to understand
monthly budget required to live in a major city when compared to the cost of living in a corresponding
metropolitan area. According to Payscale's calculator, as of Oct. 17, 2022, the cost of living in New York
City is 155% higher than the naUonal average. As a comparison, the cost of living in Chapel Hill, North
Carolina is 8% higher than the naUonal average. Comparison across countries is also possible. In a 2023
survey, Mercer, a global human resources firm, finds the ciUes with the highest cost of living include
Hong Kong; Singapore; Zurich, Geneva, and Basel in Switzerland, in that order. New York City was
ranked the costliest city in the United States followed by Los Angeles and San Francisco, and Honolulu.

Cost of Living vs. Inflation

People oXen use the phrases inflaUon and cost of living as if they were synonymous. They are not the
same, although they're closely related.
 • InflaUon is the big picture. As the cost of goods and services rises, the buying power of the
dollar falls. The inflaUon rate is oXen measured by the change in CPI, a monthly measure by
Govt. authoriUes that averages the cost of a basket of goods and services from areas around
the country. It reports the result as a percentage rise or drop in CPI.
• Cost of living has a different focus. This number represents the average cost of an
accepted standard of living including food, housing, transportaUon, taxes, and healthcare. The
cost of living is frequently used to compare minimum income needs in various locaUons.

What causes Inflation?

Supply-side factors or Cost-Push InflaIon

- When prices rise because producUon costs increase, such as raw materials and wages. The
demand for goods is unchanged while the supply of goods declines due to the higher costs of
producUon. As a result, the added costs of producUon are passed onto consumers in the form
of higher prices for the finished goods. One of the signs of possible cost-push inflaUon can be
seen in rising commodity prices such as oil and metals since they're major producUon inputs.
- Wages also affect the cost of producUon and are typically the single biggest expense for
businesses. When the economy is performing well, and the unemployment rate is low,
shortages in labor or workers can occur. Companies, in turn, increase wages to aCract qualified
candidates, causing producUon costs to rise for the company. If the company raises prices due
to the rise in employee wages, cost-plus inflaUon occurs.
- Natural disasters can also drive prices higher. For example, if a hurricane destroys a crop such
as corn, prices can rise across the economy since corn is used in many products.

Demand-Pull InflaIon

- When there's a surge in demand for a wide breadth of goods across an economy, their prices
tend to increase. While this is not oXen a concern for short-term imbalances of supply and
demand, sustained demand can reverberate in the economy and raise costs for other goods;
the result is over-heaUng or demand-pull inflaUon. As the demand for a parUcular good or
service increases, the available supply decreases. When fewer items are available, consumers
are willing to pay more to obtain the item—as outlined in the economic principle of supply
and demand. The result is higher prices due to demand-pull inflaUon.
- Consumer confidence tends to be high when unemployment is low, and wages are rising—
leading to more spending. Economic expansion has a direct impact on the level of consumer
spending in an economy, which can lead to high demand for products and services.
- Companies also play a role in inflaUon, especially if they manufacture popular products. A
company can raise prices simply because consumers are willing to pay the increased amount.
CorporaUons also raise prices freely when the item for sale is something consumers need for
 everyday existence, such as oil and gas. However, it's the demand from consumers that provide
corporaUons with the leverage to raise prices.

Built-in InflaIon or Wage-Push InflaIon

- Built-in inflaUon is related to adapUve expectaUons or the idea that people expect current
inflaUon rates to conUnue in the future. As the price of goods and services rises, people may
expect a conUnuous rise in the future at a similar rate. As such, workers may demand more
costs or wages to maintain their standard of living. Their increased wages result in a higher
cost of goods and services, and this wage-price spiral conUnues as one factor induces the other
and vice-versa.

Inflation Control Measures

KEY TAKEAWAYS

• InflaUon is a sustained increase in the general level of prices for goods and services.
• InflaUon causes a decrease in the buying power of the money.
• Cost of living measures the change, up or down, in the budget for the basic necessiUes of life,
like food, housing, and healthcare.
• The Consumer Price Index measures the overall change in consumer prices based on a
representaUve basket of goods and services over Ume.
• The CPI is the most widely used measure of inflaUon, closely followed by policymakers,
financial markets, businesses, and consumers.
• Based on its causes, inflaUon can be cost-pushed, demand-pulled or wage-pushed.
• InflaUon control is exercised through monetary and fiscal policies via both quanUtaUve and
qualitaUve measures.

SOURCES:
• Investopedia.com (consolida2ng several ar2cles)