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Principles of Economics 3. part 6 - Essay Example

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CPI is a much better measure of consumer spending power than GDP deflator that reflects the prices of goods and services that are domestically produced, but not necessarily bought by the typical consumers. In that aspect CPI is a better gauge of the cost of living of consumers.
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Principles of Economics 3. part 6
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Download file to see previous pages Prices of goods and services do not change proportionately over time. This means that some prices rise more than others and consumers substitute products and services that have become relatively less expensive. CPI overstates the cost of living by excluding the possibility for product substitution.
When the quality of a good deteriorates, the value of the dollar falls, and vice versa. Because changes in the quality are hard to measure, the basket calculates prices on the assumption that quality is constant, which distorts the CPI measures.
Although the CPI is not perfect, together with other indexes like GDP deflator or PPI, it gives a relatively useful indication about the cost of living for consumers. CPI and other price indexes are used to compare dollar values over time, by taking into account the effects on inflation.

Reference:
Mankiw, G. (2004) "Chapter 24. Measuring the Cost of Living" Principles of Economics pp. ...Download file to see next pagesRead More
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