1

The Consumer Price Index: Defined

Measures the price level for consumer goods.
Obtained by comparing, the cost of a fixed
basket of commodities purchased by Canadian
consumers in a given year with the cost of the
same basket in the base year
An indicator of changes in the consumer
prices experienced by Canadians.
Since the basket contains commodities of
unchanging or equivalent quantity and quality
the index reflects only price movements.
2
Current CPI Weights & Time Base
Those goods (about 600) represented in the CPI
are weighted according to their relative importance
in the total expenditures of consumers

CPI weights and items are obtained from surveys
conducted every ten or fewer years. The current
weights are based on 2005 consumer survey

The current time base is 2002=100

www.statcan.ca/english/sdds/2301.htm
3
Constructing and Calculating a
Simple CPI
1. Determine the market basket
choose the base year and the contents.

2. Find the prices for the items in the basket in the
base year and the current year.

3. Compute the cost of the basket in the base year
and the current year.
Now calculate the CPI
4
Calculate a Simple CPI
Union of University Provinces
Good 2000 2000
Q
n
P
$
2001 2001
Q
n
P
$
2002 2002
Q
n
P
$
Books
Pencils
Pens
10$50
100 $ 1
100$ 5
12.$50
200. $ 1
50..$10
100....$60
50.. $1.50
20..$20
CPI 2002 (base year 2000)
Bottom 2000 Q's x 2000 P's = $1100
Top 2000 Qs x 2002 Ps = $2750


5
Calculating a Simple CPI
$50 x 10 = $500
$1.00 x 100 = $100
$5 x 100 = $500
P
00
x Q
00
$1100
$60 x 10 = $600
$1.50 x 100 = $150
$20 x 100 = $2000
P
02
x Q
00

$2750
100
) Q (P
) Q (P
CPI
basket yr base yr base
basket yr base current

x100

=
) Q (P
) Q (P
CPI
basket 00 00
basket 00 02
02
6
Calculating a Simple CPI
= 250 (Base year 00 = 100)
100
$1100
$2750
CPI
02
=
One more major price index is calculated -
PPI: producer price index: market basket of
goods & services bought by firms.
note CPI= 100 in the base year.
7
Problems in Measuring CPI
1. Substitution bias
Consumers respond to relative price changes by
buying more of the relatively cheap goods
Index overstates inflation
2. Introduction of new goods
Index overstates inflation
3. Unmeasured quality change.
Index overstates inflation
8
1. Tool for deflating current dollar estimates
to obtain constant dollar estimates that
eliminate the effects of price change

The CPI Used in Four Specific Ways
9
Constant $ Estimates:
Using the CPI to compare $ values over
time
e.g. price of a tin of butterscotch
candies was $.45 in 1978 and $1.00 in
2008.

How much money in 1978 has the
same purchasing power as $1.00 in
2008?
10
Candy was more in 1978.
$1.37
$0.45
37.6
114.5
=
=
Suppose
CPI
baseyr.02
in 1978= 37.6
CPI
2002=100
in 2008 = 114.5
Value in
2008 $s of
1978 Price

)
`

= Price 1978
1978
2008
2002 _ _
2002 _ _
year Base
year Base
CPI
CPI
11
Bank of Canada Inflation Calculator
http://www.bankofcanada.ca/en/inflation_calc.htm
2. Escalate a given dollar value over time to
preserve the purchasing power of that value
Adjust contracted payments such as wages, rents,
leases, child support: private and public pension
programs, personal income tax deductions
The CPI Used in Four Specific Ways
12
Using the CPI to Compare $ Values Over
Time
Annual family expenses
100
year current" " for CPI
$ Current
s $' 2002, constant =
Current $
CPI
2002 = 100 Constant 2002, $s
1997 $20,000 90.5 $22,099
2000 $25,000 96.6 $25,879
2004 $30,000 105.6 $28,409
2007 $35,000 111.9 $31,278
Nominal Real
13
Using the CPI to adjust payments
e.g. Divorce Agreement
The basic child support payment is
$600/month effective May 1, 2003. Every
May 1 thereafter, payments will be adjusted
by the percentage change over 12 months in
the March CPI for Canada.
Suppose the CPI increased 2.2% in the first year,
1.4% in the second.
On May 1, 2004, payment increases by
2.2% x $600 = $13.20
On May 1, 2005, payment increases by
1.4% x $613.20 = $8.58
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3. Real & Nominal Interest Rates
Interest: payment of money income in the future for a
transfer of money in the past.
Interest rate paid by the bank
nominal rate of interest.
Interest rate corrected for inflation
real rate of interest.
real interest rate =
nominal interest rate inflation rate.
The CPI Used in Four Specific Ways
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The CPI Used in Four Specific Ways
4. Setting and evaluating economic policies
Bank of Canada uses the CPI to
evaluate its policies
Economic analysis and research
Costs of Inflation
Inflation is a process of rising prices.
We measure the inflation rate as the
percentage change in the average
level of prices or the price level.
16
Costs of Inflation
A fall in purchasing power of money?
The inflation fallacy.

Inflation of prices goes hand
in hand with inflation of
incomes.
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Costs of Inflation
1. Tax: shoe leather costs
Inflation is like a tax imposed on
everyone who holds money.
Avoidance of this tax uses up resources.
2. Menu costs
Updating price lists & posted prices;
eg., printing new menus, catalogues, etc.
3. Increased variability of
relative prices
Reduced efficiency of the price system.
Confusion & inconvenience discouraging
investment and economic growth

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Costs of Inflation
5.Special costs associated with
unexpected inflation
random redistribution of income.
(nothing to do with merit or need)
for debtors who gain at the expense of
creditors
for people on fixed incomes
for those workers whose wages dont
keep up with inflation.
4. Hyperinflation and economic
breakdown
19
Statistics Canada
Statistics Canada: Daily
http://www.statcan.ca/english/dai-quo/

Find the latest CPI and Unemployment Rate

Macro Economic Aggregate:
Unemployment
20
Jobs and Unemployment
The Unemployment Rate
in Canada since 1926.
During the 1930s, the
unemployment rate hit
20 percent
The lowest rate
occurred during World
War II at 1.2 percent
The unemployment rate
has averaged 6.7
percent since World War
II

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Unemployment: Basic Definitions
labour force: total number of adults
15 and over who are either employed
or are unemployed and seeking work
employed: number of people who hold
jobs.
unemployed: number of people who do not
have jobs but are available and looking for
work.

22
Unemployment Rate
100

unemployed employed
unemployed
100
force labour
unemployed people of #
force) (labour

=
=


23
Not in Labour Force:
8.608 million
Employed:
16.867 million
Unemployed:
1.079 million
Labour Force
17.946 Million
Adult Population (over 15 years), 2007
Civilian, Non-Institutional Labour Force
Population (page 117 in text)
Labour Force Pop:26.554M
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Labour Force: Participation Rate
Percentage of the population (aged
15 years and over) that is in the
labour force
labour force
labour force population
(total working age population: total # people 15 years or older: except
those living on a reservation, those in the military or in jail, or in a hospital or
institution for an extended period of time)
X 100
25
Canadian Labour Force Survey
To be called employed a person must..

To be called unemployed a person must be
available for work, (looking for work) and
must fall into one of the three following
categories:
http://www.statcan.ca/english/Subjects/Labour/LFS/lfs-en.htm
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Unemployed
1) Not working, but making specific
efforts within previous 4 weeks to
find a job
2) Laid off from a job within previous
26 weeks and waiting for recall
3) Waiting to begin a new job within
the next 4 weeks
Employment and Unemployment
The Unemployed
Unemployment varies by region and
population segment.
Tends to be higher among
teenagers, men, and residents of
Newfoundland and Labrador.

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Qualifications of the Unemployment
Data
-Unemployment rate as measured by the
Labour Force Survey can be misleading
for these reasons:
1) Unrealistic wage expectations
2) Discouraged workers
3) Part time workers
4) Underground (illegal) workers not
counted in the statistics
3 Different Types of Unemployment
1. Frictional Unemployment
Unemployment from normal
turnover in the economy.
Short term, such as temporary
layoffs or changing jobs.
UE insurance can increase this type
of unemployment.
By-product of labour force mobility.
3 Different Types of Unemployment
2. Structural Unemployment
Workers lack the necessary skills for jobs
that are available
Have skills that are no longer in demand.
Result of a changing, dynamic economy.
Tends to be longer term
Government training programs help
reduce structural unemployment.
3 Different Types of Unemployment
3. Cyclical Unemployment
Due to short term cyclical
fluctuations in the economy.
Occurs during a recession due to
inadequate demand.
Viewed as especially correctable
through government policies.
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Full Employment, Unemployment
Rate
defined as the sum of frictional and
structural unemployment
Unemployment that is unavoidable
and to be expected in a growing
and changing economy.
The Full Employment Unemployment Rate has many names
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Full Employment
Potential GDP: The level of total output that
can be sustained in the long run without
inflation and at full employment.
Target rate of unemployment.
Natural Rate
Rate that is sustainable without
creating inflation
Rate associated with potential GDP.
Currently between 6% and 7% in
Canada.

34
The Figure shows the
relationship between
unemployment and real
GDP.
As the unemployment
rate fluctuates
around the natural
unemployment rate
(part a), real GDP
fluctuates around
potential GDP (part b).
LABOUR TRENDS AND FLUCTUATIONS
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What is this rate?
What factors affect the choice of the target rate
of unemployment?
1) sustainable without inflation.
Target Rate of Unemployment/
Full Employment/Natural Rate
2) demographics - affect frictional
and structural unemployment.
3) structural change.
4) social and institutional structure - eg.
imperfect labour markets, changes in government
EI affects frictional unemployment.
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Costs of Unemployment
Financial uncertainty.
Anxiety, tension, and despair.
Loss of potential output to society.
Potential consumption is reduced
Loss of human capital
37
Seasonal Unemployment/
Seasonal Adjustment
Seasonal unemployment: predictable
changes in the unemployment rate due to
seasonal factors
Seasonal adjustment: attempts to remove
the predictable seasonal unemployment
from the reported unemployment
left with a measure that more
accurately reflects the changes in the
state of the economy.