Administrative - Economic Pharmacy I

Chapter 4.

THE DATA OF MACROECONOMICS

MEASURING THE COST OF LIVING

TP. Hồ Chí Minh - 2022 1

 MEMBERS
OBJECTIVES
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Administrative - Economic Pharmacy I

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 CONTENTS
Administrative - Economic Pharmacy I

1. The Consumer Price Index

2. Correcting Economic Variables for the Effects of

Inflation

3. Conclusion

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 Administrative - Economic Pharmacy I
CONTENTS

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 Administrative - Economic Pharmacy I
CONTENTS

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 1. THE CONSUMER PRICE INDEX
Administrative - Economic Pharmacy I

• The consumer price index (CPI) is a measure of the overall cost of the
goods and services bought by a typical consumer

• In this section, we discuss how the CPI is calculated and what

problems arise in its measurement

• We also consider how this index compares to the GDP deflator,

another measure of the overall level of prices, which we examined in
the preceding chapter

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 1. THE CONSUMER PRICE INDEX
Administrative - Economic Pharmacy I

CPI is used to monitor changes When the CPI rises, the typical family
in the cost of living over time has to spend more money to
maintain the same standard of living

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 1. THE CONSUMER PRICE INDEX
Administrative - Economic Pharmacy I

Economists use the term inflation to describe a

situation in which the economy’s overall price
level is rising

The inflation rate is the percentage change in the

price level from the previous period.

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 1. THE CONSUMER PRICE INDEX
Administrative - Economic Pharmacy I

The consumer price index (CPI), a common measure of inflation,

measures the price change over time for a basket of goods and services.
The basket is representative of consumer spending patterns, and the
change in its price represents the rate of inflation faced by consumers as
a whole.

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 1. THE CONSUMER PRICE INDEX
Administrative - Economic Pharmacy I

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 1. THE CONSUMER PRICE INDEX

1. 1. HOW THE CPI IS CALCULATED

Administrative - Economic Pharmacy I

When the BLS calculates the CPI and the

inflation rate, it uses dataon the prices of
thousands of goods and services

To see exactly how these statistics are

constructed, let’s consider a simple
economy in which consumers buy only two
goods: hot dogs and hamburgers

Five steps for CPI’s calculation

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 1. THE CONSUMER PRICE INDEX

1. 1. HOW THE CPI IS CALCULATED

Administrative - Economic Pharmacy I

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 1. THE CONSUMER PRICE INDEX

1. 1. HOW THE CPI IS CALCULATED

Administrative - Economic Pharmacy I

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 1. THE CONSUMER PRICE INDEX

1. 1. HOW THE CPI IS CALCULATED

Administrative - Economic Pharmacy I

What method does Vietnam use to calculate its CPI?

GSO has used the CPI calculation method according to

• The guidance of the International Labor Organisation (ILO) since 1995.

• The latest ILO Consumer Price Index Compilation Guide issued in 2020.
→ Therefore, the GSO’s CPI calculation method has reflected consumer price
performance in the market and ensures comparability with other countries.
To calculate the CPI, the General Statistics Office identifies the list of popular
consumer goods and services of the people, also known as a "basket" of
goods.

• The total number of goods represented in the "basket" of goods in the period
2020-2025 is 752 items.
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 1. THE CONSUMER PRICE INDEX

1. 1. HOW THE CPI IS CALCULATED

Administrative - Economic Pharmacy I

What method does Vietnam use to calculate its CPI?

• 63 provinces and centrally-run cities build their own consumer price survey list for
the calculation of CPI.

• The prices are investigated at places trading in goods and services, including
markets, trade centres and supermarkets.

• Every month, 63 localities have collected information on prices from 40,000 survey
points.

• Then, the GSO will determine the structure of household expenditure based on this
list of goods and services.

• Now, GSO uses the Computer-Assisted Personal Interviews (CAPI) software to

implement consumer price surveys

• We publish the consumer price index on the 29th of every month on the website of
the General Statistics Office
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 1. THE CONSUMER PRICE INDEX

1. 1. HOW THE CPI IS CALCULATED

Administrative - Economic Pharmacy I

In addition to the consumer price index for the economy as a whole, the US
Bureau of Labor Statistics (BLS) also calculates:

• Narrow category price indexes of goods and services, such as food, clothing
and energy

• CPI for all goods and services excluding food and energy, a statistic known as
the Core CPI

• Producer price index, which is the cost that businesses, not consumers, spend
to buy a basket of goods and services

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 1. THE CONSUMER PRICE INDEX

1. 2. PROBLEMS IN MEASURING THE COST OF

Administrative - Economic Pharmacy I

LIVING

• The goal of the consumer price index is to measure changes in the

cost of living
• In other words, the CPI tries to gauge how much incomes must rise to
maintain a constant standard of living
• The CPI, however, is not a perfect measure of the cost of living
• Three problems with the index are widely acknowledged but difficult
to solve:
(1) - Substitution bias
(2) - Introduction of new goods
(3) - Unmeasured quality change

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 1. THE CONSUMER PRICE INDEX

1. 2. PROBLEMS IN MEASURING THE COST OF

Administrative - Economic Pharmacy I

LIVING

(1)- Substitution bias

Over time, some prices rise faster than others.

• Consumers substitute toward goods that become relatively cheaper,
mitigating the effects of price increases.
• The CPI misses this substitution because it uses a fixed basket of
goods.
• Thus, the CPI overstates increases in the cost of living.

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 1. THE CONSUMER PRICE INDEX

1. 2. PROBLEMS IN MEASURING THE COST OF

Administrative - Economic Pharmacy I

LIVING
(1)- Substitution bias

EXPENSIVE AFFORDABLE

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 1. THE CONSUMER PRICE INDEX

1. 2. PROBLEMS IN MEASURING THE COST OF

Administrative - Economic Pharmacy I

LIVING
(2) - Introduction of new goods

When a new good is introduced, consumers have more variety from

which to choose, and this in turn reduces the cost of maintaining the
same level of economic wellbeing

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 1. THE CONSUMER PRICE INDEX

1. 2. PROBLEMS IN MEASURING THE COST OF

Administrative - Economic Pharmacy I

LIVING
(2) - Introduction of new goods

Suppose you could choose between a $100 gift certificate at a large

store that offered a wide array of goods and a $100 gift certificate at a
small store with the same prices but a more limited selection

Which would you prefer?

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 1. THE CONSUMER PRICE INDEX

1. 2. PROBLEMS IN MEASURING THE COST OF

Administrative - Economic Pharmacy I

LIVING
(3) - Unmeasured quality change

If the quality of a good deteriorates from one year to the next while its
price remains the same, the value of a dollar falls, because you are
getting a lesser good for the same amount of money. Similarly, if the
quality rises from one year to the next, the value of a dollar rises.

→ The BLS does its best to account for quality change

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 1. THE CONSUMER PRICE INDEX

1. 2. PROBLEMS IN MEASURING THE COST OF

Administrative - Economic Pharmacy I

LIVING
(3) - Unmeasured quality change

This first difference between the CPI and the GDP deflator is particularly
important when the price of oil changes

• The United States produces some oil, but much of the oil we use is
imported

• As a result, oil and oil products such as gasoline and heating oil make
up a much larger share of consumer spending than of GDP

• When the price of oil rises, the CPI rises by much more than does the
GDP deflator

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 1. THE CONSUMER PRICE INDEX

1. 2. PROBLEMS IN MEASURING THE COST OF

Administrative - Economic Pharmacy I

LIVING
(3) - Unmeasured quality change

The second and subtler difference between the GDP deflator and the CPI
concerns how various prices are weighted to yield a single number for the
overall level of prices

• The CPI compares the price of a fixed basket of goods and services to the
price of the basket in the base year

• By contrast, the GDP deflator compares the price of currently produced

goods and services to the price of the same goods and services in the base
year

Thus, the group of goods and services used to compute the GDP deflator
changes automatically over time 24
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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
Administrative - Economic Pharmacy I

• The purpose of measuring the overall level of prices in the economy

is to allow us to compare dollar figures from different times

• Now that we know how price indexes are calculated, let’s see how we
might use such an index to compare a dollar figure from the past to a
dollar figure in the present
2.1. Dollar Figures from Different Times
2.2. Indexation
2.3 Real and Nominal Interest Rates

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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 1. DOLLAR FIGURES FROM DIFFERENT
Administrative - Economic Pharmacy I

TIMES
1931 2015

high or low compared to the

salaries of today’s players

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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 1. DOLLAR FIGURES FROM DIFFERENT
Administrative - Economic Pharmacy I

TIMES
• To answer this question, we need to know the level of prices in 1931
and the level of prices today. Part of the increase in baseball salaries
compensates players for higher prices today. To compare Ruth’s
salary to those of today’s players, we need to inflate Ruth’s salary to
turn 1931 dollars into today’s dollars.
• The formula for turning dollar figures from year T into today’s dollars
is the following:

→ A price index such as the CPI measures the price level and thus
determines the size of the inflation correction
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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 1. DOLLAR FIGURES FROM DIFFERENT
Administrative - Economic Pharmacy I

TIMES
1931 2015

high or low compared

to the salaries of
today’s players ???

Government statistics show a CPI of 15.2 for 1931 and 237 for 2015.

Ruth’s salary in 2015 dollars

$1,247,368
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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 1. DOLLAR FIGURES FROM DIFFERENT
Administrative - Economic Pharmacy I

TIMES

Babe Ruth Clayton Kershaw

We find that Babe Ruth’s 1931 salary is equivalent to a salary today of over $1.2
million. That is a good income, but it is only a third of the average player’s salary
today and only 4% of what the Dodgers pay Clayton Kershaw

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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 1. DOLLAR FIGURES FROM DIFFERENT
Administrative - Economic Pharmacy I

TIMES
1931 2015

Salary in 2015 dollars = $75,000 x (237/15.2) = $1,169,408

→ HERBERT HOOVER’S SALARY IS HIGHER THAN
BARACK OBAMA’S SALARY

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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 1. DOLLAR FIGURES FROM DIFFERENT
Administrative - Economic Pharmacy I

TIMES

Indexation

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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 2. INDEXATION
Administrative - Economic Pharmacy I

• Price indexes are used to correct for the effects of inflation when
comparing dollar figures from different times. This type of correction
shows up in many places in the economy. When some dollar amount
is automatically corrected for changes in the price level by law or
contract, the amount is said to be indexed for inflation
Ex: Many long-term contracts between firms and unions include
partial or complete indexation of the wage to the CPI. Such a
provision, called a cost-of living allowance - COLA, automatically raises
the wage when the CPI rises

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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 2. INDEXATION
Administrative - Economic Pharmacy I

• Indexation is also a feature of many laws. Social Security benefits, for

instance, are adjusted every year to compensate the elderly for
increases in prices
• The brackets of the federal income tax - the income levels at which
the tax rates change - are also indexed for inflation
• There are, however, many ways in which the tax system is not indexed
for inflation, even when perhaps it should be

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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 3. REAL AND NOMINAL INTEREST RATES
Administrative - Economic Pharmacy I

Is he $100 richer than he was when he

made the deposit a year earlier

This Photo by Unknown Author

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is licensed under CC BY-NC
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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 3. REAL AND NOMINAL INTEREST RATES
Administrative - Economic Pharmacy I

Cost 1 DVD
= $10

How many DVDs can he

buy in 2020 and in 2021

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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 3. REAL AND NOMINAL INTEREST RATES
Administrative - Economic Pharmacy I

How many DVDs can he buy in 2020 and in 2021 ?

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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 3. REAL AND NOMINAL INTEREST RATES
Administrative - Economic Pharmacy I

• To understand how much a person earns in a savings account, we need to

consider both the interest rate and the change in prices
• The interest rate that measures the change in dollar amounts is called the
nominal interest rate and the interest rate corrected for inflation is called
the real interest rate
Real interest rate = Nominal interest rate - Inflation rate
• The real interest rate is the difference between the nominal interest rate and
the rate of inflation
• The nominal interest rate tells you how fast the number of dollars in your bank
account rises over time, while the real interest rate tells you how fast the
purchasing power of your bank account rises over time
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 2. CORRECTING ECONOMIC
VARIABLES FOR THE EFFECTS OF
INFLATION
2. 3. REAL AND NOMINAL INTEREST RATES
Administrative - Economic Pharmacy I

Source: U.S. Department of Labor; U.S. Department of Treasury

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 3. CONCLUSION
Administrative - Economic Pharmacy I

• When comparing dollar figures from different times, it is important to keep

in mind that a do llartoday is not the same as a dollar 20 years ago or, most
likely, 20 years from now
• This part has discussed how economists measure the overall level of prices
in the economy and how they use price indexes to correct economic
variables for the effects of inflation
• Price indexes allow us to compare dollar figures from different points in time
and, therefore, get a better sense of how the economy is changing

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 Tài liệu tham khảo
Administrative - Economic Pharmacy I

1. N. Gregory Mankiw (2017). Principles of macroeconomics. Cengage

Learning, 8th Edition, ISBN: 9781305971509.
2. N. Gregory Mankiw (2021). Brief principles of macroeconomics.
Cengage Learning, ISBN: 9780357133507.
3. Niall Kishtainy, George Abbot, John Farndon, Frank Kennedy, James
Meadway, Christopher Wallace, Marcus Weeks (2012). The Economics
Book (Big Ideas Simply Explained). DK ADULT, ISBN: 9780756698270
4. Flynn, Sean Masaki (2018). Economics for Dummies: Website
Associated W/Book. John Wiley & Sons Inc. 3rd Edition, ISBN:
9781119476382

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Administrative - Economic Pharmacy I

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