The inflation rate in country x, as measured by changes in the consumer price index, is 5%. Does it mean that?

Question

The inflation rate in country x, as measured by changes in the consumer price index, is 5%. Does it mean that every individual's cosy of living has increased by 5%? Explain your answer clearly with 3 reasons.

Answer 1

Inflation is the increase of prices of consumer goods (consumer basket). If Inflation is 5%, it does tell that individuals' cost of living increased, but not exactly 5%. The CPI measures only the expediture of individuals of basic goods (food, entertainment, utilities, vehicles) but it does not include items for investments (stocks, real state). Another problem with the CPI is that the weight attached to each class of goods and services is held constant for years at a time. Therefore, when consumers lower their cost of living by buying more items whose relative price has fallen and fewer items whose relative price has risen, the CPI will not show a decline in the cost of living. Moreover, the difficult problem of allowing for changing quality has never been solved. Nor can the government inspectors who collect the data from retailers track down all the sales and discounts of which consumers are so keenly aware. As a result of these and other factors, the consumer price index reflects inflation trends only with a long delay and portrays an artificially smooth path for the inflation rate.

Answer 2

The CPI is a measure of the average price of a set of goods and services typically bought by consumers. As it covers most things that consumers buy, it is a measure of the AVERAGE cost of living in a country. Some prices will have increased by more than the average, while others will have increased by less.

Different individuals purchase different amounts of each good or service. For example, a poor person spends a greater proportion of their money on food, while a rich person is more likely to purchase luxuries. If food prices increase by more than 5%, while luxuries (eg plasma TVs)increase by less than 5%, the average price increase will still be 5%. However, the cost of living for the poor person will be more than 5% and for the rich person will be less than 5%.

Similarly, price increases can vary by city, wile the CPI is just an average. The average cost of living in some cities will be more than for others, even though the average is 5%.

There are also measurement problems with the CPI since some price increases are hard to measure. For example, the CPI includes computer equipment. However, pentium computers didn't exist 20 years ago, and it is not easy to compare a modern computer to an old 1980s computer to work out what has happened to computer prices. Similar problems exist with many goods (eg ABS braking wasn't as common on cars a decade ago as it is today). To get around these problems, statisticians must approximate the CPI. However, this leads to errors that mean that the CPI may not give a complete picture of changes in the cost of living.

Answer 3

No, it does not mean that the cost of living for every person has increased by that.

Because:

1- As another answer says, every person has a different composition of expenses: some people own a house, others rent one, some travel a lot, others are in wheelchairs and never travel, but have a lot of medical expenses, etc.

2- Every person could find cheaper ways of buying the same good. If I decide to buy in bulk instead in retail, the cost of that good will go down for me. (if the difference between bulk and retailer price compensates the overall price increase due to inflation)

3- The inflation rate is an average and it does not take into account other differences: where do I buy, how much, how often, where do I live, etc

Answer 4

"A" consumer price index is a list of consumer prices over time. "The" Consumer Price Index leaves-out several key expenses and thus paints a rosier picture than reality warrants. As for being "economic masterminds," Republicans simply subscribe to the crazy (according to Democrats) idea that repeating past actions is likely to yield results similar to those you got in the past. Thus our "economics ideas are nothing more than recognition of history. In contrast, leading Democrat POLICY MAKERS actually claim that repeating past actions is virtually guaranteed to yield a completely opposite result from what you got every other time.