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100 PART • Producers, Consumers, and Competitive Markets F IGURE 3.23 COMPARING GASOLINE RATIONING TO THE FREE MARKET Some consumers will be worse off, but others may be better off with rationing With rationing and a gasoline price of $1.00 she buys the maximum allowable 2000 gallons per year, putting her on indifference curve U1 Had the competitive market price been $2.00 per gallon with no rationing, she would have chosen point F, which lies below indifference curve U1 However, had the price of gasoline been only $1.33 per gallon, she would have chosen point G, which lies above indifference curve U1 Spending on other goods ($) 20,000 D G 14,000 F U1 3000 10,000 15,000 20,000 Gasoline (gallons per year) In §1.3, we introduced the Consumer Price Index as a measure of the cost of a “typical” consumer’s entire market basket As such, changes in the CPI also measure the rate of inflation • cost-of-living index Ratio of the present cost of a typical bundle of consumer goods and services compared with the cost during a base period In §1.3, we explained that the Producer Price Index provides a measure of the aggregate price level for intermediate products and wholesale goods would choose point F, which lies below indifference curve U1 (At point F, she purchases 3,000 gallons of gasoline and has $14,000 to spend on other goods.) But, consider what would happen if the price of gasoline were only $1.33 per gallon Then the relevant budget line would be the line associated with a maximum gasoline consumption of about 15,000 gallons per year ($20,000/$1.33) She would choose a point such as G, where she purchases more than 3,000 galls of gasoline and has more than $14,000 to spend on other goods In this case, she would be better off without rationing, since point G lies above indifference curve U1 We can conclude, therefore, that while rationing is a less efficient means of allocating goods and serves, under any particular rationing scheme some individuals may well be better off, even though others will necessarily be worse off *3.6 Cost-of-Living Indexes The Social Security system has been the subject of heated debate for some time now Under the present system, a retired person receives an annual benefit that is initially determined at the time of retirement and is based on his or her work history The benefit then increases from year to year at a rate equal to the rate of increase of the Consumer Price Index (CPI) Does the CPI accurately reflect the cost of living for retirees? Is it appropriate to use the CPI as we now do—as a cost-of-living index for other government programs, for private union pensions, and for private wage agreements? On a similar note, we might ask whether the Producer Price Index (PPI) accurately measures the change over time in the cost of production The answers to these questions lie in the economic theory of consumer behavior In this section, we describe the theoretical underpinnings of cost indexes such as the CPI, using an example that describes the hypothetical price changes that students and their parents might face
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