Prices & Inflation- Economics(Co2-E).Ppt2003 File

8/12/2019 Prices & Inflation- Economics(Co2-E).Ppt2003 File

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(c) 2000,2001, 2002 Claudia Garcia - Szekely 1

Measuring Inflation:The Consumer Price Index(CPI)




InflationMeasures the rate of CHANGE in prices.

Is calculated from a price index , fordifferent time periods: months, quarters,

years.



(c) 2000,2001, 2002 Claudia Garcia - Szekely©2001ClaudiaGarcia-Szekely 3

Price IndexA price index is a number thatrepresents overall prices for a givenperiod of time –say a year.




The Consumer Price Index (CPI)Principal source of information for trends in consumerprices and inflation.Used for escalation of contract amounts and paymentsamong individuals and organizations.

Used to adjust payments to:Social Security recipientsFederal and Military retireesFood Stamps and School Lunches

Used to adjust individual income tax brackets.




The Consumer Price I ndexThe CPI is a measure of prices for a fixed

basket of goods and services ofconstant quantity and quality purchased by consumers.



The Consumer Price I ndexMeasures the overall cost of the goods andservices bought by a typical consumer.



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The CPI1. Fix the basket : select the mostcommonly purchased items by

conducting surveys.

3 trips

1 computer

5 Doctor visits2 tuitions



The CPI2. Find the prices of the

items included in thebasket: scouts go everymonth looking for theseprices.

Ticket = $600

Doctor Visit=$100Tuition =$20,000

Computer=$1200



The CPI3. Compute the cost of the items

in the basket each year.

3 Tickets = $1800

5 Doctor Visits= $500

2 Tuitions = $40,000

1 Computer= $1200



Cost of the Basket Y2000

$43,500



The CPI4. Choose a base year -

the benchmark forcomparison- andcompute the cost ofthe basket in the base year…Say 1995

Ticket Price in1995 =500

Doctor Visit in 1995 =$90

Tuition in 1995 =$20,000

Computer Price in1995 =$1500



Cost of the Basket in the Base Year (1995 )

$43,450

$1,500

Note: Same items,same quantities,same qualities we

used for 2000



The CPI5. Compute the CPI.

CPI (Year 2000) =

Cost of Basket in 2000

Cost of Basket Base Year x100



Calculating the CPI1. Fix the quantities and items in the basket.

2. Find the prices of these items.3. Compute the cost of the items in the basket

at each year’s prices. 4. Choose a base year -the benchmark for

comparison-

CPI (Year 2000) =Cost of Basket in 2000Cost of Basket Base Year

x100



Updating the Market BasketCPI revisions occur approximately every 10years.

The most important revision is theintroduction of a new “market basket” The last revision to the CPI started in1998 and completed in 2000.





The CPI: ExampleYear Price X Quantity X Price Y Q

2000 1 4 2 2

2001 2 5 3 32002 3 6 4 5



Use 4 units of X and 2 units of Y as therepresentative quantities (the basket)

Year Price X Quantity X Price Y Qua

2000 1 4 2 2

2001 2 5 3 32002 3 6 4 5



Calculate Cost of basket ineach year… Year Price X Quantity X Price Y Qua2000 1 4 2 2 4 4 8

2001 2 5 3 3 8 6 1

2002 3 6 4 5 12 8 2

X

X

X

X

X

X +

+

+

=

=

=



CPI = Basket cost Year X /Basket costbase year.

(20 /8)*100= 250202002

CPICost of the

BasketYear

(8/8)*100= 10082000

(14 /8)*100

= 175142001



Calculating the InflationRate

Year CPI Inflation rate

2000 100

2001 175 752002 250 42.86

175 - 100

100 X 100= 75%

250 - 175

175 X 100= 43%





The CPI includes the following categories of goods and services:

FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, fullservice meals and snacks);HOUSING (rent of primary residence, owners' equivalent rent, fuel oil,bedroom furniture);APPAREL (men's shirts and sweaters, women's dresses, jewelry);TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicleinsurance);MEDICAL CARE (prescription drugs and medical supplies, physicians'

services, eyeglasses and eye care, hospital services);RECREATION (televisions, cable television, pets and pet products, sportsequipment, admissions);EDUCATION AND COMMUNICATION (college tuition, postage, telephoneservices, computer software and accessories);OTHER GOODS AND SERVICES (tobacco and smoking products, haircutsand other personal services, funeral expenses).



Although not a “price” CPI includes… Also included are various government-charged user fees:water and sewerage charges, auto registration fees, and

vehicle tolls.The CPI also includes taxes:

such as sales and excise taxes that are directly associatedwith the prices of specific goods and services.

The CPI excludes taxes:such as income and Social Security taxes that are notdirectly associated with the purchase of consumer goodsand services.

The CPI does not include investment items:such as stocks, bonds, real estate, and life insurance.Because these items relate to savings and not to day-to-day consumption expenses .



The Core Consumer Price Index

Measures what consumers are paying for goods andservices at malls, grocery stores and other retaillocations.

Unlike the overall CPI, it excludes food and energyprices, which can bounce around enough each month todistort the overall price trend picture.

Buyers should pay attention to the report because it'sone of the most important indicators of inflation. Highinflation equals high interest rates. Low inflation allows

interest rates to fall.




InflationInflation refers to an INCREASE in the pricelevel from one period to the next.Inflation can be high (20%) or low (2%)When inflation drops from 20% to 2% prices stillINCREASE, but not as much as the previous timeperiod.




DeflationDeflation refers to a DECREASE in the pricelevel from one period to the next.Deflation shows up as a NEGATIVE number forthe inflation rate: a –5% “inflation” means thatprices DECREASED by 5%.

This is not only a slowing down of inflation buta DROP in prices.




The GDP Deflator vs. The CPIGDP Deflator reflects the prices of all

goods and services produced

domestically bought by consumers, thegovernment and other countries.




The GDP Deflator vs. The CPIThe CPI reflects prices of goods

purchased by consumers only . The

CPI does not take into accountprices of goods and services boughtby the government or foreigners.




The GDP Deflator vs. The CPI2. The CPI uses a fixed basket whereas

the GDP deflator uses prices ofcurrently produced goods.

1

2

5

3




Moving dollar values forward intime…

1930 2000

$100

CPI (1930) = 16.7CPI (2000)

=172.2

(172.2)/(16.7)=10.31

Prices in 2000 are 10.31 times larger than in 1930

You need to have 10.31 times as much money in2000

Multiply by 10.31

?$1,031




?

Moving dollar values back intime…

1930 2000

$ 9.70

CPI (1930 ) = 16.7 CPI (2000) = 172.2

(172.2)/(16.7)=10.31

Prices in 1930 were one tenth what they are in2000

You need a tenth of the money in 1930

Divide by 10.31 $100




ExampleIf you want to know what is the equivalent in today’s dollars of an$80,000 salary in 1931,1. Find the ratio of prices:CPI in 2000 / CPI in 1931 = 172.2/16.7 = ___2. Multiply 80,000 by that # =________

An $80,000 salary in 1931 is equivalent to a$_________salary in 2000.

10.31824,910.2

824,910.2




Using the Inflation CalculatorThe Presidential salary from 1909-1949 was$75,000 annually (President Hoover 1929 - 1933)CPI = 17.1

George W. Bush salary is $200,000 annually. CPI =179.9

Do we pay our president a salary equivalent to that ofPresident Hoover?




Moving dollar values forwardin time…

1929 2002

$75,000

CPI (1929) = 17.1 CPI (2002) = 179.9

(179.9)/(17.1)=10.52Multiply by 10.52 ?$789,035

President Hoover’s salary is equivalent to $789,035while Bush’s salary is $200,000




?

Moving dollar values back intime…

1929 2002

$ 19,011

CPI (1929) = 17.1 CPI (2002) = 179.9

(179.9)/(17.1)=10.52

President Hoover made $75,000 while the equivalentof Bush’s salary is $19,011

Divide by 10.52 $200,000




Problems Measuring the Cost of Living1. Substitution Bias: Because the basket is

fixed, the CPI does not account forsubstitutions consumers do in response tohigher prices.

Substitution away from “frozen desserts”to “cake - like desserts”.




Geometric Mean EstimatorEmploys a set of fixed expenditure proportions as

weights in averaging the prices of individual itemswithin a CPI basic index.Fixing the relative expenditure proportions ratherthan the relative quantities implies that consumers can

alter the quantities of goods and services they buywithin the narrow range of a CPI category, when therelative prices of those goods and services change.



Problems with CPI… 2. New Goods Bias: new goods mean greater variety

and thus consumers need to spend less to attain thesame (or higher) standard of living. CPI does notreflect this change in the purchasing power of adollar.

3. Unmeasured Quality change: If quality improves,the value of the dollar rises.

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Prices & Inflation- Economics(Co2-E).Ppt2003 File

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