Transcript Are people better off now than they used to be?

Economists use
Consumer Price Index [CPI]
to estimate
real wages and costs
from nominal wages and costs.
Computation of CPI
• An army of economists gathers prices on a
standard “market basket” of goods at fixed
time periods (month, year)
Computation of CPI
• An army of economists gathers prices on a
standard “market basket” of goods at fixed
time periods (month, year).
• The prices of the baskets is compared.
Computation of CPI
• An army of economists gathers prices on a
standard “market basket” of goods at fixed
time periods (month, year).
• The prices of the baskets is compared.
• The prices are converted to index
numbers.
The CPI can be used to adjust
economic data to remove the
effect of changing underlying
prices.
Suppose that CPI for three
years is as follows:
Year 1
Year 2
Year 3
50
100
200
Year 1
Year 2
Year 3
CPI= 50
CPI= 100
CPI= 200
That is, things cost twice as much, on
average, in Year 2 (Y2) as in Year 1 (Y1).
So, $1.00 could buy twice as much as in
Year 1 (Y1) as in Year 2 (Y2).
So, the value of the Y1 dollar is twice that of
the Y2 dollar
Relative values can be
computed using this formula:
CPI of base year / CPI of object year * 100
(Object year is the year being compared to the
base year)
Let’s refer to the formula
CPI of base year / CPI of object
year
as a formula for a
conversion factor
Conversion factor =
CPI of base year / CPI of object year
Use the conversion factor to
adjust the prices:
Price * conversion factor =
adjusted price
Using previous terminology:
Nominal price * conversion factor =
real price (relative to base year)
Combining the formula for adjusted price
with that for the conversion factor:
Nominal price * (CPI base year / CPI object
year) = real price
Additional terminology:
• Current values (prices, wages, etc.) are
prices (nominal values) at the value of the
currency at that time
• Constant values (prices, etc.) are prices in
real values, i.e., as if the currency had the
value of the base year.
Problem:
In 1930, Babe Ruth earned his
maximum salary: $80,000.
How does this compare with
today’s salaries?
2007 average salary:
$2,944,556
Highest paid player:
Alex Rodriguez @
$23,428,571
What would the average salary
and A-Rod’s salary have been
in constant (1930) dollars?
What would Babe Ruth’s salary
have been in constant (2006)
dollars?
Babe Ruth: $80,000
2007 average: $2,944,556
Alex Rodriguez: $23,428,571