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2.) CPI – measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI
Part 1
Part 2
Part 3
- a sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money.
Inflation
- is measured by the annual percentage change in consumer prices.
Rate of Inflation
***Please remember that a fall in the rate of inflation is not the same thing as a fall in prices!
1.) Inflation Vocabulary
- when the rate of inflation becomes negative.
Deflation
- the value of money becomes worthless.Hyperinflation
1.) Inflation Vocabulary
Stagflation - persistent high inflation combined with high unemployment and stagnant demand in a country's economy.
It was mostly caused my gas and raw material prices were high causing high prices and
high unemployment.
1920’s Germany had this hyperinflation problem where the money basically became worthless
caused by a bad economic policy after losing world war one.
{1946 Hungry Hyperinflation At the height of the
inflation, prices were rising at the rate of 150,000% PER DAY. By then, the government had stopped collecting taxes altogether because even a single day’s delay in collecting taxes wiped out the value of the money the government collected.
2.) CPI – measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI
- measures the typical consumer’s cost of living with only the typical things that are purchased.
- the main way to measure inflation.
Consumer Price Index (CPI)
1.) Inflation Vocabulary
How the CPI Is Calculated:
- Government surveys consumers to determine what’s in the typical consumer’s “shopping basket.”
2.) CPI – measuring Inflation
1.) Fix the “basket”
- Government then collects data on the prices of all the goods in the basket.
2.) Find the prices
3.) Compute the basket’s cost
-Use the prices to compute the total cost of the basket.
How the CPI Is Calculated:
- The CPI in any year equals:
2.) CPI – measuring Inflation
4.) Choose a base year and compute the index
100 xcost of basket in current year
cost of basket in base year
- The percentage change in the CPI from the preceding period:
6.) Compute the inflation rate
CPI this year – CPI last year
CPI last year
Inflation
ratex 100%=
5.) ?
CPI basket:
{4 比萨, 10 饺子}
120元 x 4 + 3元 x 10 = 510
110元 x 4 + 2.5元 x 10 = 465
100元 x 4 + 2元 x 10 = 440
cost of basket
3.00元
2.50元
2.00元
price of
饺子
120元2013
110元2012
100元2011
price of
比萨year
Compute CPI in each year
2011: 100 x (440/440) = 100
2012: 100 x (465/440) = 106
2013: 100 x (510/440) = 116
using 2011 base year:
CPI – example…
x4
x10
Inflation rate:
6%106 – 100
100x 100%=
9.4%116 – 106
106x 100%=
CPI basket:
{10 kg beer, 20 kg coffee}
The CPI basket cost $1050
in 2009, the base year.
A. Compute the CPI in 2010.
B. What was the CPI inflation rate from 2010-2011?
price of
beer
price of
coffee
2009 $35 $35
2010 $40 $40
2011 $65 $50
CPI – another example…
x10
x20
Questions to try:
CPI basket:
{10 kg beer, 20 kg coffee}
The CPI basket cost $1050
in 2009, the base year.
price of
beer
price of
coffee
2009 $35 $35
2010 $40 $40
2011 $65 $50
CPI – another example…
x10
x20
A. Compute the CPI in 2010:
Cost of CPI basket in 2010
= ($40 x 10) + ($40 x 20) = $1200
CPI in 2010 = 100 x ($1200/$1050) = 114
CPI basket:
{10 kg beer, 20 kg coffee}
The CPI basket cost $1050
in 2009, the base year.
price of
beer
price of
coffee
2009 $35 $35
2010 $40 $40
2011 $65 $50
CPI – another example…
x10
x20
B. What was the inflation rate from 2010-2011?
Cost of CPI basket in 2011
= ($65 x 10) + ($50 x 20) = $1650
CPI in 2011 = 100 x ($1650/$1050) = 157
CPI inflation rate = (157 – 114)/114 = 38%
2.) CPI – measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI
2.1) Weighting
2.1) Weighting CPI
- measures the typical consumer’s cost of living with only the typical things that are purchased.
Consumer Price Index (CPI)
- in which each item influences the index in proportion to its price per it’s share.
Weighted Index
AS exams love to mention this, so please
don’t forget it!
Types of G &S
Proportion
spend by
households
Average price of
goods
Weighted average
price
Clothing 25 $40 0.25 x $40 = $10
Entertainment 15 $60 0.15 x $60 = 9
Food 40 $5 0.40 x $5 = $2
Travel 20 $20 0.20 x 20 = $4
2.1) Weighting CPI
Total = 100% Price of basket = $25
The proportion of total spending on each category is used to weigh the average prices of each good to find their weighted averages.
Let’s call this the base year…
Base Year 5.) Attach the weights
Types of G &S
Proportion
spend by
households
Average price of
goods
Weighted average
price
Clothing 25 $44 0.25 x $44 = $11
Entertainment 10 $90 0.10 x $90 = 9
Food 50 $8 0.50 x $8 = $4
Travel 15 $20 0.15 x 20 = $3
2.1) Weighting CPI
Total = 100% Price of basket = $27
Prices have changed, but so has the weighted proportion of some items.
Current Year
100 xWeighted average prices in current year
Weighted average prices in base year
$27
$25CPI = 108=
5.) Attach the weights
2.) CPI – measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI
3.) Problems of CPI
*** The general problem is that CPI tends to overstate the actual increase in the cost of living.
- Introduction of New Goods
- Substitution Bias
- Unmeasured Quality Change
- Discount sales
3.) Problems of CPI
Substitution Bias - Over time, some prices rise faster than others.
- Consumers substitute toward goods that become relatively cheaper.
- The CPI misses this substitution because it uses a fixed basket of goods.
偏见
Example: You stop buying beef (in the CPI
basket) and buy lamb instead, (not in the CPI basket) hard to know and measure why people make these
choices and if they choice something not in the basket.
3.) Problems of CPI
Introduction of New Goods
- The introduction of new goods increases variety, allows consumers to find products that more closely meet their needs.
-
- -The CPI misses this effect because it uses a fixed basket of goods.
Example: You buy more Mini Ipads (not in the
basket) because they are new and cheap, but since they are new they can’t already be in the basket yet.
Everyone has a smart phone today, but they did not exist 15 years ago, so when should the government decide to put it
in the basket?
3.) Problems of CPI
Unmeasured Quality Change
- Improvements in the quality of goods in the basket increase the value of each dollar.
- The CPI tries to account for quality changes but probably misses some, as quality is hard to measure.
Example: Many electronic products today are
cheaper and better quality then in the past, how to measure that?
3.) Problems of CPI
- Firms may decrease prices due to overstock or misreads of the market.
-The CPI may not compensate for these short term changes.
Discount sales
Example: Stores often have sales, how can the
government keep track of all the prices in the whole country when many places
have discounts and others don’t?
Prices online are much cheaper usually right? So how to measure it exactly if
you’re the government?
- a sustained increase in the cost of living or the general price level leading to a fall in the purchasing power of money.
Inflation
- is measured by the annual percentage change in consumer prices.
Rate of Inflation
1.) Inflation Vocabulary
- when the rate of inflation becomes negative.
Deflation
- the value of money becomes worthless.Hyperinflation
- ………………………….hless.Stagflation
- measures the typical consumer’s cost of living with only the typical things that are purchased.
- the main way to measure inflation.
Consumer Price Index (CPI)
1.) Inflation Vocabulary
How the CPI Is Calculated:
- Government surveys consumers to determine what’s in the typical consumer’s “shopping basket.”
2.) CPI – measuring Inflation
1.) Fix the “basket”
- Government then collects data on the prices of all the goods in the basket.
2.) Find the prices
3.) Compute the basket’s cost
-Use the prices to compute the total cost of the basket.
How the CPI Is Calculated:
- The CPI in any year equals:
2.) CPI – measuring Inflation
4.) Choose a base year and compute the index
100 xcost of basket in current year
cost of basket in base year
- The percentage change in the CPI from the preceding period:
6.) Compute the inflation rate
CPI this year – CPI last year
CPI last year
Inflation
ratex 100%=
5.) ?
2.1) Weighting CPI
- measures the typical consumer’s cost of living with only the typical things that are purchased.
Consumer Price Index (CPI)
- in which each item influences the index in proportion to its price per it’s share.
Weighted Index
{
Types of G &S
Proportion
spend by
households
Average price of
goods
Weighted average
price
Clothing 25 $44 0.25 x $44 = $11
Entertainment 10 $90 0.10 x $90 = 9
Food 50 $8 0.50 x $8 = $4
Travel 15 $20 0.15 x 20 = $3
2.1) Weighting CPI
Total = 100% Price of basket = $27
Prices have changed, but so has the weighted proportion of some items.
Current Year
100 xWeighted average prices in current year
Weighted average prices in base year
$27
$25CPI = 108=
5.) Attach the weights
3.) Problems of CPI
*** The general problem is that CPI tends to overstate the actual increase in the cost of living.
- Introduction of New Goods
- Substitution Bias
- Unmeasured Quality Change
- Discount sales