Question

Measuring The Cost of Living Discussion Question:

How to measure the cost of living?

What are the issues of measuring the cost of living by using CPI?

1) A brief summary of your ideas of how to measure the cost of living.

2) What are the issues of measuring the cost of living by using CPI?

Answer 1

1) There are 3 ways to measure cost of living:

- Consumer price index (CPI)

- Producer price index (PPI)

- GDP deflator

Each of these has their own advantages and disadvantages but a common point is these all are measures of cost of living. I do briefly explain my ideas on the measures of cost of living below:

a) CPI -

It is a measure of the value of all the items what consumers purchase including both goods and services. Mainly it measures the change in prices of the market basket, here market basket represent similarly like what samples of the population showing, bought by households. It is from the consumer's point of view. The change in CPI mainly percentage change used as the measure of inflation. It is used to measure real values for salary, wages, for regulating prices etc. CPI along with population census is used as important national economic statistics in most of the countries.

Calculating CPI for single item:

and CPI for multiple items calculated as:

b) Producer price index (PPI) -

It is also a measure of inflation but it is from the producer's point of view, it also plays an important role for giving a warning about inflation as because if the price of raw materials increases then obviously price of final good also increases in near future. Producer price index is also commonly known as the wholsale price index. Basically, it measures the average change in prices what producers get for their product. It is calculated as:

(Price in the current year - Price in the base year) / Price in the base year * 100

Let assume WPI for the base year is assumed as 100 and so WPI for the current year is calculated by adding the above value and base WPI value. For example, let the above value as x so the current wpi = x + 100.

c) GDP deflator

It calculates the value of all the goods produced by the nation, it is a measure of overall change in price. It stands for all the goods produced domestically. It measures the ratio of nominal GDP to the real GDP formula to calculate this is:

2) issues with cpi discussed below:

- Mainly It measures the cost of private goods and services, it also means public goods and services not included.

- It is calculated based on average price of a basket consumed by average consumers.

- It took time to include new goods and eliminate old ones from the basket. it also means that there is a logistical time lag between new and old goods in the basket.

- Quality improvement and its effect on consumers lifestyle not taken in account.

- CPI does not account quality difference if the goods are similar goods.