Example question calculating CPI and inflation | AP Macroeconomics | Khan Academy

Khan Academy
21 Feb 201807:44
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TLDRThis instructional video explains the Consumer Price Index (CPI), a measure of the cost of a standard basket of goods. Using Jacksonia as an example, the video demonstrates how to calculate CPI for 2015 and 2017 with 2016 as the base year, resulting in CPIs of 50 and 124, respectively. It also calculates the inflation rates between 2015-2016 (100%) and 2016-2017 (24%). The video concludes by discussing how the CPI might overstate cost of living changes due to potential substitution effects when the price of some goods increases more than others, leading to shifts in consumer purchasing habits.

Takeaways
  • 📊 The CPI, or Consumer Price Index, measures the cost of a typical basket of goods over time.
  • 🛒 The example uses the nation of Jacksonia, where a typical household buys four loaves of bread, three pounds of cream cheese, and eight books each week.
  • 📈 The prices of these goods for the years 2015, 2016, and 2017 are provided to calculate the CPI and inflation rates.
  • 📚 The CPI for 2017 is calculated using 2016 as the base year, resulting in a CPI of 124, indicating a 24% increase in prices from the base year.
  • 📉 The CPI for 2015, using 2016 as the base year, is 50, showing that prices in 2015 were half of those in 2016.
  • 💹 The rate of inflation between 2015 and 2016 is 100%, as prices doubled from 2015 to 2016.
  • 📊 The rate of inflation between 2016 and 2017 is 24%, as the CPI increased from 100 to 124.
  • 🤔 The script suggests that the CPI might not perfectly reflect changes in the cost of living due to potential substitution effects among goods in the basket.
  • 🛍️ People might change their consumption patterns in response to price changes, which could affect the accuracy of the CPI as an indicator of cost of living.
  • 🔄 Countries attempt to update the basket of goods to reflect typical consumption, but this adjustment may not always be accurate or timely.
  • 📝 The transcript provides a step-by-step guide to calculating CPI and understanding its implications, highlighting the complexity of measuring inflation.
Q & A

  • What is the Consumer Price Index (CPI)?

    -The Consumer Price Index (CPI) is a measure used to track the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

  • What is the base year for calculating the CPI in the given transcript?

    -In the provided transcript, the base year for calculating the CPI is 2016.

  • What are the three goods included in the typical basket for the nation of Jacksonia?

    -The typical basket for the nation of Jacksonia includes four loaves of bread, three pounds of cream cheese, and eight books.

  • What was the cost of the weekly basket in 2015 according to the transcript?

    -The cost of the weekly basket in 2015 was $93.

  • What was the cost of the weekly basket in 2016 according to the transcript?

    -The cost of the weekly basket in 2016 was $186.

  • What was the cost of the weekly basket in 2017 according to the transcript?

    -The cost of the weekly basket in 2017 was $230.

  • How is the CPI calculated for a year other than the base year?

    -The CPI for a year other than the base year is calculated by dividing the cost of the basket in that year by the cost of the basket in the base year and then multiplying by 100.

  • What was the CPI for 2015 using 2016 as the base year?

    -The CPI for 2015 using 2016 as the base year was 50.

  • What was the CPI for 2017 using 2016 as the base year?

    -The CPI for 2017 using 2016 as the base year was 124.

  • What is the rate of inflation between 2015 and 2016?

    -The rate of inflation between 2015 and 2016 was 100%, as prices doubled from the CPI of 50 in 2015 to 100 in 2016.

  • What is the rate of inflation between 2016 and 2017?

    -The rate of inflation between 2016 and 2017 was 24%, as the CPI increased from 100 in 2016 to 124 in 2017.

  • Why might the inflation rate between 2016 and 2017 overstate the changes in the cost of living?

    -The inflation rate between 2016 and 2017 might overstate the changes in the cost of living because the basket of goods might change due to substitution effects. If some goods' prices increase significantly while others remain stable, consumers may shift their consumption towards the relatively cheaper goods, such as cream cheese in this case, which could result in a lower actual growth in the cost of living.

Outlines
00:00
📊 Calculating CPI and Inflation Rates

The first paragraph introduces the Consumer Price Index (CPI), a measure of the cost of a typical basket of goods. It uses the nation of Jacksonia as an example, where households buy a set amount of bread, cream cheese, and books weekly. The prices for these items in 2015, 2016, and 2017 are provided. The instructor guides viewers to calculate the CPI for 2017 and 2015 using 2016 as the base year, resulting in CPIs of 124 and 50, respectively. The inflation rates between 2015 and 2016 and between 2016 and 2017 are also calculated, showing 100% and 24% increases, respectively. The paragraph concludes by prompting viewers to consider why the inflation rate might overstate changes in the cost of living.

05:03
📈 Understanding Inflation Rate and Its Limitations

The second paragraph delves into the specifics of calculating the inflation rate between 2016 and 2017, which is determined to be 24%. It then challenges the viewer to think about why the calculated inflation rate might not accurately reflect the changes in the cost of living. The instructor explains that different goods in the basket can experience varying rates of price inflation, leading to a substitution effect where consumers might shift their purchases towards cheaper items. This can result in a lower actual growth in the cost of living than what the CPI suggests. The paragraph highlights the imperfections of the CPI as an indicator, noting that while countries attempt to adjust the basket of goods to reflect typical consumption, it is not always an accurate representation.

Mindmap
Keywords
💡CPI
CPI stands for Consumer Price Index, which is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as bread, cream cheese, and books, in this video's context. It's a key economic indicator used to understand the cost of living and inflation. In the video, the CPI is calculated for the years 2015, 2016, and 2017 using 2016 as the base year, helping to illustrate changes in the cost of goods over time.
💡Basket of goods
A basket of goods refers to a collection of items that a typical household might purchase regularly. It's used as a standard set of items for calculating the CPI. In the video, the basket for the nation of Jacksonia includes four loaves of bread, three pounds of cream cheese, and eight books, which are priced differently across the years 2015, 2016, and 2017.
💡Inflation
Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. The video discusses calculating the rate of inflation between 2015 and 2016 and between 2016 and 2017 by comparing the CPI values of those years. The script uses the CPI to illustrate that prices doubled from 2015 to 2016, indicating 100% inflation, and grew by 24% from 2016 to 2017.
💡Base year
A base year is a reference point or starting year used for comparison in statistical analysis, such as calculating the CPI. In the script, 2016 is chosen as the base year, meaning the CPI for that year is set to 100, and the CPI for 2015 and 2017 are calculated relative to it.
💡Cost of living
Cost of living refers to the amount of money needed to sustain a certain level of living, including basic expenses such as housing, food, taxes, and healthcare. The video discusses how changes in the CPI can reflect changes in the cost of living. However, it also points out that the CPI might not perfectly represent changes in the cost of living due to potential substitution effects when the prices of different goods in the basket change at different rates.
💡Substitution effect
The substitution effect in economics occurs when consumers switch to cheaper alternatives as the price of a good increases. In the video, it's suggested that if the price of bread and books increases significantly while the price of cream cheese remains the same, consumers might buy more cream cheese and less bread and books, which could lead to an overstatement of the CPI and the inflation rate.
💡Price index
A price index is a normalized average (often 100) of prices of a basket of goods or services in the current period compared to prices in a base period. The CPI is a type of price index that specifically measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The video demonstrates how to calculate the CPI for different years to understand the rate of inflation.
💡Typical household
A typical household is a hypothetical average household used for statistical analysis and economic modeling. In the video, the purchases of a typical household in Jacksonia are used to define the basket of goods for calculating the CPI, which includes specific quantities of bread, cream cheese, and books.
💡Growth rate
The growth rate is the rate at which a quantity increases over time. In the context of the video, the growth rate is used to calculate the rate of inflation between different years by comparing the CPI values. For example, the CPI grew from 50 in 2015 to 100 in 2016, indicating a 100% growth rate in prices.
💡Purchasing power
Purchasing power is the value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. In the video, the concept is indirectly discussed when explaining how inflation affects the cost of living and the need to adjust the CPI to reflect changes in purchasing power over time.
Highlights

Introduction to the Consumer Price Index (CPI) and its purpose in measuring the cost of a typical basket of goods.

The example of the nation of Jacksonia and their weekly consumption of bread, cream cheese, and books.

Providing the prices of goods in Jacksonia for the years 2015, 2016, and 2017 in a table format.

Calculating the CPI for 2017 using 2016 as the base year.

Calculating the CPI for 2015 using 2016 as the base year and achieving a CPI of 50.

The CPI calculation method: basket cost in a year divided by the cost in the base year, multiplied by 100.

Calculating the CPI for 2017 results in a CPI of 124.

Understanding the rate of inflation between 2015 and 2016 as 100%, indicating prices doubled.

Calculating the rate of inflation between 2016 and 2017 as 24%.

The concept of substitution effect and its impact on the CPI as a measure of cost of living.

The potential overstatement of the CPI in reflecting changes in the cost of living due to substitution effects.

The importance of rebalancing the basket of goods in CPI calculations to reflect typical consumption patterns.

The limitations of CPI as an indicator of cost of living due to varying inflation rates among different goods.

The example of cream cheese remaining constant in price and its potential impact on consumer behavior.

Encouraging viewers to pause and think about the implications of CPI calculations and inflation rates.

Transcripts

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Consumer Price IndexCPI CalculationInflation RateCost of LivingEconomic IndicatorJacksonia EconomyBasket of GoodsPrice IndexInflation AnalysisEconomic Education