2. 

measures the typical consumer’s cost of living
the basis of cost of living adjustments
(COLAs) in many contracts and in Social
Security
3. 1. Fix the “basket.”
The Bureau of Labor Statistics (BLS) surveys
consumers to determine what’s in the typical
consumer’s “shopping basket.”
2. Find the prices.
The BLS collects data on the prices of all the
goods in the basket.
3. Compute the basket’s cost.
Use the prices to compute the total cost of
the basket.
4. 4. Choose a base year and compute the index.
The CPI in any year equals
100 x
cost of basket in current year
cost of basket in base year
5. Compute the inflation rate.
The percentage change in the CPI from the
preceding period.
Inflation
=
rate
CPI this year – CPI last year
CPI last year
MEASURING THE COST OF LIVING
x 100%
4
5. basket: {4 pizzas, 10 shakes}
year
price of
pizza
price of
shakes
2007
100
20
100 x 4 + 20 x 10 = 600
2008
110
25
110 x 4 + 25 x 10 = 690
2009
120
30
120 x 4 + 30 x 10 = 780
cost of basket
Compute CPI in each year using
2007 base year
2007: 100 x (600/600) = 100
2008: 100 x (690/600) = 115
Inflation rate:
115 – 100
x 100%
15% =
100
130– 115
x 100%
13% =
115
2009: 100 x (780/600) = 130
MEASURING THE COST OF LIVING
5
6. The Consumer Price Index is a measure of the cost of
living. The CPI tracks the cost of the typical
consumer’s “basket” of goods & services.
 The CPI is used to make Cost of Living Adjustments
and to correct economic variables for the effects of
inflation.
 The real interest rate is corrected for inflation
and is computed by subtracting the inflation rate from
the nominal interest rate.

6
7. 


The Consumer Price Index is a measure of the
cost of living. The CPI tracks the cost of the
typical consumer’s “basket” of goods &
services.
The CPI is used to make Cost of Living
Adjustments and to correct economic
variables for the effects of inflation.
The real interest rate is corrected for inflation
and is computed by subtracting the inflation
rate from the nominal interest rate.
8. 
Utility
 The want-satisfying power of a good or service

Utility Analysis
 The analysis of consumer decision making based on utility
maximization

Util
 A representative unit by which utility is measured
9. 
Marginal Utility
 The change in total utility due to a one-unit
change in the quantity of a good or service
consumed
Change in total utility
Marginal utility =
Change in number of units consumed
10. 
Diminishing Marginal Utility
 The principle that as more of any good or service
is consumed, its extra benefit declines
 Increases in total utility from consumption of a
good or service become smaller and smaller as
more is consumed during a given time period.
11. 
Suppose you are very hungry and offered a burger to eat.
The satisfaction which you derive from the first piece of
burger ,would be the maximum because intensity of your
hunger is more but eventually it goes on decreasing and
therefore the satisfaction that you derive from the other
bite goes on decreasing.
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