<Last updated 13.04.2020>
Hi! If you are interested in Economics, I’ve prepared the below to help your understanding about money and cost. You should take a look at this short article in which I discuss what is Purchasing Power of Money and how we measure the cost of living.
Money has purchasing value: It is the power that money has, to be traded/exchanged with other goods and services. The quantity of goods and services that an amount of money can buy at a specific point in time. If prices of goods and services rise, it means that the same amount of money can buy less amount of those goods and services. So there is a negative relationship between prices and purchasing power.
A way to measure the purchasing power of money, or the general level of prices, is by using an economic indicator called Consumer price index (CPI). This is also a measure of the cost of living, and by comparing the index, period by period, we can have a measure/metric of the changes in the prices of goods and services through time purchased from the “average” household (that represents the household population). We compare usually the current year with a year in the past, the base year.
How it is calculated:
a) Define consumer basket of goods and services: a sample of goods and services purchased by a representative household. Prices are recorded and adjusted depending on the population. These goods and services are categorized based on Eurostat (the statistical office of the European Union, responsible for publishing high-quality Europe-wide statistics and indicators that enable comparisons between countries and regions) and data are collected from contacting a survey:
Consumer price index (CPI) is updated from time to time to reflect people’s preferences. If people spend a big part of their income for some categories of goods and services, these have to be included in this basket of the representative consumer.
How do we calculate the CPI exactly? Here is an example:
Consumer price index (CPI) Calculation:
Base year > 2005 , CPI 2005 = 100 CPI 2006 = (10,600 / 10,000) x 100 = 106 CPI change 2005-2006 = (106 – 100)/100 x 100 = 6% CPI change 2006-2007 = (113 – 100/100 x 100 = 13%
What are the benefits of calculating the CPI and have these data and information available?
> They are used for calculating the Inflation Rate, the % increase in prices, period by period, and thus the increase in the cost of living.
> For calculating automated CPI Adjustment.
> To perform adjusting, for the effects of inflation, to other economic indicators such us the GDP that provide us with useful information regarding the performance of the economy.
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