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Limitations of CPI, PPI, and GDP Measures

The document answers two questions about economic measures and interest rates. For the first question, it states that the consumer price index, producer price index, and GDP are imperfect measures of cost of living. The CPI overstates inflation by about 1% due to factors like substitution of goods and new products. PPI measures supplier prices rather than household purchases. GDP includes non-household purchases. For the second question, it defines nominal interest rates as unadjusted for inflation, while real interest rates subtract expected inflation from nominal rates to give the true rate of return.

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Jobelle Grace Soriano
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7 views1 page

Limitations of CPI, PPI, and GDP Measures

The document answers two questions about economic measures and interest rates. For the first question, it states that the consumer price index, producer price index, and GDP are imperfect measures of cost of living. The CPI overstates inflation by about 1% due to factors like substitution of goods and new products. PPI measures supplier prices rather than household purchases. GDP includes non-household purchases. For the second question, it defines nominal interest rates as unadjusted for inflation, while real interest rates subtract expected inflation from nominal rates to give the true rate of return.

Uploaded by

Jobelle Grace Soriano
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd

Answer the following questions:

1. How consumer price index (cpi), producer price index (ppi) and GDP is an imperfect measure
of the cost of living?

- The consumer price index is an imperfect measure of the cost of living for three reasons. First,
it does not take into account consumers' ability to substitute toward goods that become
relatively cheaper over time. Second, it does not take into account increases in the purchasing
power of the dollar due to the introduction of new goods. Third, it is distorted by unmeasured
changes in the quality of goods and services. Because of these measurement problems, the CPI
overstates annual inflation by about one percentage point. Producer price index is based on
prices of supplies and inputs bought by producers of goods and services. GDP is not a good
measure of the cost of living as it includes prices of many products not purchased by
households for example: aircraft, fire engines, factory buildings, office complexes, and
bulldozers.

2. What is the distinction between real and nominal interest rates?

- A real interest rate is the interest rate that takes inflation into account. This means it adjusts
for inflation and gives the real rate of a bond or loan. To calculate the real interest rate, you
first need the nominal interest rate, the calculation used to find the real interest rate is the
nominal interest rate minus the actual or expected inflation rate. While, a nominal interest rate
refers to the interest rate before taking iflation into account. It is the interest rate quoted on
bonds and loans. The nominal interest rate is a simple concept to understand. The disadvantage
of using nominal interest rate is that it does not adjust for the inflation rate.

Jobelle Grace Soriano

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