Syndicate
Determining the Standard of Life with Price Index
Besides facilitating measuring and interpreting of inflation, price indexes also allow you to easily measure the very important difference between real prices and nominal prices. The nominal prices are simply the prices expressed in money that can change in time due to inflation. Since normal prices can change, economists are more into focusing on real prices, that they calculate when you have to sacrifice a type of good to get another type of good, without taking into account what happens to the nominal prices.
Let’s suppose for example that you work and make around $10 an hour working at a university campus and the cost for a CD is of $20. The real cost of a CD for you is of two hours of work. Suppose that the next year the prices of all the goods double, but your salary also doubles and you are not making $20 an hour, this means that now the CD costs $40. The result is that you still need to work two hours in order to buy that CD. So even though the price of the CD has increased, the number of hours that you would actually need to work in order to get it would not change.
Through the building of price indexes such as the CPI, economists can say how it changes the real standard of life of the people year by year.
The Problem with Price Indexes
The use of the price indexes to observe the evolution of the cost of life is not a perfect system. Here are some of the most significant problems with it:
- It is impossible for a basket of goods and services to truly reflect the expenses incurred by a family. The offices of work statistics try to keep a register of what the typical family buys, of a determined number of people, when they calculate the price index of the consumer (CPI). However, the families consider it be completely different, not only in terms of what they buy but also of how much they buy of each thing.
- The basket of goods and services becomes obsolete. The estadigrafs frequently wait for too long before including new types of good in the basket. In the United States for example, the Labor Statistics Office took a great number of years in including the camera disc recorders, even though these were quickly replacing videocassette recorders. If the CPI does not include in the new popular products, it does not capture the changes of prices that consumers are interested in.
- The basket of goods and services cannot have quality in mind. Price is not the only thing that consumers are interested in. for example, what happens in the case of a pizza being the same price but improves its quality from one year to the next? You will in this case be getting something better for the same price, but this is not reflected in the data. This is a problem that is particularly serious for articles such as cell phones, computers, video games, etc. The quality of these keeps getting better every single year, while the prices are being kept the same or go down.
Each one of these problems has professionals worried from the government that is constantly improving the price indexes and the statistic method to try to over those problems.